Prices are a very familiar thing to everyone living in the developed world. Whether you go to Walmart, a boutique, or even shop online, there are set prices that dictate how much money you would need to spend to obtain the item you are shopping for. What many people fail to consider, however, is how those prices are determined. In early markets, and in some settings that still exist today, these prices would be agreed upon through bartering. A buyer would approach a seller, or vice versa, and each would make offers on how much they believed the item was worth, until they reached an agreement or decided not to make a transaction. The current market is very similar, but rather than only one individual bartering with one seller, the “haggling” is done at a much larger scale.
In Chapter Three of Peter Bylund’s book The Seen, the Unseen, and the Unrealized: How Regulations Affect Our Everyday Lives, he discusses all of the factors that go into setting a market price for a good or service. Bidding begins at a very early stage for entrepreneurs who hope to market a good, long before that good is even made. The raw materials that will be used to produce the good, as well as the equipment needed, the time it will take to produce and distribute the good, and the labor that will be required are all considered by the entrepreneur before they even begin their endeavor (Bylund, 33). These costs can all be estimated by their current values. That is to say, if one wishes to produce wooden furniture, the costs of wood, lathes, drills, saws, electricity, and a shop space can all be estimated by what others are charging for them currently. In the same vein, the cost of labor can be estimated by seeing what other shops pay skilled tradespeople to produce the furniture. While all these costs are (relatively) easy to estimate, it is much more complicated to estimate how much money can be made through this endeavor (Bylund, 35)
As entrepreneurs begin to collect the materials and equipment needed to begin their enterprise, they need to have an idea of how much money there is to be made in their market, and whether or not that makes the cost required “worth it” to them. To continue the furniture example above, if an entrepreneur realized they could make three-hundred dollars for each dining room table they crafted, they would then need to assess the demand in their area for those tables. If the demand is enough to turn a profit after subtracting the “sunk” costs of labor, materials, equipment, space, and delivery, then the entrepreneur will move forward with the venture. However, it gets more complicated than that. The costs of the factors for production and consumer goods are decided in two very different manners, as explained by Bylund below:
“[...] it has to do with timing. Consumers bid for and therefore help determine prices of products they can consume in the present, and producers likewise bid for consumers’ money expecting to cover their already incurred costs or satisfy other wants in the present. But means of production have value only because they will contribute to producing a value arising in the future. So whereas consumers in some sense speculate due to their having incomplete knowledge about both their own wants and the product’s ability to satisfy those wants, entrepreneurs bid because they expect the capital good (a produced means of production) to contribute to an undertaking that they anticipate will realize value for consumers and therefore generate revenue at a future time (Bylund, 34).”
While the factors of production (materials, equipment, labor, etc.) are relatively easy to understand, and the concept of supply and demand is familiar to most, the issue of entrepreneurial timing is much more difficult to grasp. Entrepreneurs must use their knowledge of the market to decide when to buy the factors of production, how long production can take to still turn a profit, and when it will be best to sell their goods (Bylund, 35).
How are entrepreneurs, or even economists, expected to understand the intricacies of timing when it comes to a global market such as the one we have today? Friedrich Hayek attempts to explain this conundrum in his article “The Use of Knowledge in Society”, which was published in the American Economic Review in 1945. Beginning with a broad view of the economy, and the knowledge required to make the most effective economic decisions, Hayek asserts that the general problem is how to utilize resources in the best manner possible when only a select few know the importance behind the production (Hayek, 520).
Hayek goes on to assert that there is a debate between compiling all information with a small group of people to make decisions; to allow the information to remain widespread, and thus the decisions to be a general consensus; and to reach some general compromise in the way decisions are made (Hayek, 521). While it may seem logical to allow economists and those who have studied these subjects in depth to make the majority of decisions, that overlooks a very key component of the economy: a knowledge of a certain point in time and place (Hayek, 521). While economists may understand a broad range of issues that can impact supply and demand, price changes, and other economic factors, it is important not to overlook the “common knowledge” that is used in thousands of steps along the process of production.
“To know of and put to use a machine not fully employed, or somebody’s skill which could be better utilized, or to be aware of a surplus stock which can be drawn upon during an interruption of supplies, is socially quite as useful as the knowledge of better alternative techniques. And the shipper who earns his living from using otherwise empty or half-filled journeys of tramp-steamers, or the estate agent whose whole knowledge is almost exclusively one of temporary opportunities, or the arbitrageur who gains from local differences of commodity prices, are all performing eminently useful functions based on special knowledge of circumstances of the fleeting moment not known to others (Hayek, 522).”
Hayek goes on to write about the general contempt that was held against this type of knowledge, as it was regarded as “guarded” or “hidden” during his time (Hayek, 522). The use of this knowledge, which was often gained from a lifetime of labor and expertise rather than formal education, was seen as disreputable by professional economists, who contended that the knowledge should be widespread and shared with all. What the professionals of the time did not consider was how to share all of this information (Hayek, 522). While we have widespread use of the internet today, it is still not feasible to share that much information with everyone who could make use of it. How could one express all the nuances of a shipping dock, or the intricacies that go into logging and producing lumber, in such an up-to-date manner to make the information useful to economists or entrepreneurs who are interested in these markets? In my opinion, the sheer amount of information that would be shared would inundate the reader to such an extent that any valuable information would be lost.
To summarize what has been discussed above, there is a wide range of issues that goes into deciding a price point for any given good or service, including the factors of production (raw materials, equipment, land, labor, time, etc.), the demand that is expected for the product, and the time in which the good is being produced and sold. The knowledge of all of these factors cannot be centralized in one individual, or group of individuals, as the nuances that impact each factor are too many to be effectively communicated in a timely manner.
Bylund, P. L. (2016). Chapter 3: What Prices Communicate. In The Seen, the Unseen, and the Unrealized: How regulations affect our everyday lives (pp. 27–45). essay, Lexington Books.
Hayek, F. A. (1945). The Use of Knowledge in Society. American Economic Review, 35(4), 519-30.
