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“I will be honest with you: It troubles me that the American people seem to want to know so little about issues – that they are satisfied with 128 characters.”– Rex Tillerson, former US Secretary of State 2016-2017
I have written a number of posts about democracy, how it was born – and why it is dying. In Born in Blood and The Numbers Game I wrote about its violent birth and why – in spite of all who tried to kill it – it was allowed to live. In The Price of Democracy and Faux News I then continued with an analysis of how the rich and powerful are twisting the news – even the Internet – shaping a society which serves their own needs and desires. And how this is linked with the growth of monopolies and dreams of dictatorships.
Today, I am following up with a new post in a series, which is delving into the foundations of modern-day capitalism. We have already seen how the accumulation of wealth is built into the very structure of the system, and how the incessant call for privatisation – far from being a way of making the public service sector more efficient – is generally merely an excuse for further concentration of wealth and power.
And now, let us dig one level further down again. Into the world of the science behind it all…
“Economics is the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses.”– Lionel Robbins, Economist & Author
What is science?
Well, put simply – science is a fiction of the rational mind. It is a fiction because it does not actually exist; it is an idea. Or maybe even an ideal. Science embodies the belief that the Universe is rational, subject to natural laws, and that we can understand those given time and logic.
That, at least, is the general idea. But there are many kinds of sciences, and some of them deal with phenomena which are illogical, irrational, and not at all – at least by our current understanding – subject to “natural laws” as such.
One of those is Economics.
It is a social science. The definition by Lionel Robbins, in the quote above, would have you believe that it is also a rational, maybe even objective science. But really, it isn’t. It is a science which studies how people use and share resources – of any kind and for any means. And because people are, fundamentally, emotional and impulsive – and most definitely neither cold machines nor computers programmed by pure logic – economics is a science which tries to make sense out of that chaos… and often fails to do so.
To the extent that there are “laws” of Economics, those are actually merely guidelines. Sage advice, if even that much. Because really, what we deal with here are human choices. And what we do, and may choose to do, is neither rational nor subject to natural laws…
So, keeping that in mind, let me introduce you to the Economic equivalent of the Theory of Relativity: the Law of Supply and Demand.
“The value of anything is a function of its supply weighed against demand.”
Now, this is really basic. And by basic, I mean fundamental. Most things economic will actually, in the last instance, boil down to some variation of that single principle: the supply of something weighed against the demand for it, will determine the price you can get for it. And by “it” I mean – literally anything.
We see this in effect, all around us every day. It is a cornerstone of free market capitalism.
- If supply goes up, while demand remains the same, prices will generally fall.
- If demand grows (and supply remains the same), so will the price.
Very simple. Deceptively simple, in fact, for actual life is often quite a bit more complicated than that. But it is a useful rule-of-thumb.
It is also merely a rule-of-thumb. These adjustments do not happen instantaneously; the market will always need some time to adjust and, depending upon what we are dealing with, those adjustments may take several years to occur – if they happen at all.
But let’s take a practical example, where we can see the Law in effect: The Case of the Danish Butter Cookies.
For many years, a tin of Danish Butter Cookies was – at least in the US – regarded as one of the finest hostess gifts you could give. They were delicious, a favourite of the Danish royalty, and came in those classic, blue metal tins which gave an instant impression of class and style. And of course, they were also quite expensive, marketed abroad as an exclusive product by the Danish company which manufactured them. So they were a relatively rare treat.
But then, something happened. A Danish competitor decided that the US market was lucrative enough that it also wanted a bite of it. So they contacted some vendors and offered to sell them Danish Butter Cookies at very competitive prices.
What happened next is a textbook classic. Suddenly everyone could walk into a supermarket and pick up a tin of Danish Butter Cookies off the shelf; it was no longer an exclusive and expensive gift; it was just another commonplace commodity – and you could get it everywhere.
And… prices plummeted.
Well, that is what we would expect, based on the Law of Supply and Demand: a new supplier enters the market, so supply increases. If supply increases while demand remains the same, prices will fall.
So far, so simple.
Now, let’s take a look at what actually happened – but this time in slow-motion…
Danish Butter Cookies are, as per the name, a Danish product. They are quite easy to make, and there are several manufacturers, but only one of them was actually exporting to the US at the time. Which meant that in effect, that one company had a de-facto monopoly on the sale of Danish Butter Cookies within the States.
Monopolies are interesting. If you have a monopoly on something, that means that you are the only one who can sell it. So anyone who wants one of your things will have to pay the price you ask of them: they cannot get it anywhere else, after all, so they either have to pay your price or do without.
So, let’s say you have a monopoly; what do you do? Do you try to sell your stuff cheaply and at a low profit? Or… do you raise the price as high as you can, to maximise your profits?
Most monopolies would simply raise prices as high as they could, to maximise their earnings. Which is, by the way, why monopolies are generally abhorred. But yes, (in case you were wondering) that was actually a trick question. For there are circumstances where it makes eminent sense for a monopoly to keep prices quite low. We will get to an example of that in a moment.
In the case of the Danish Butter Cookies, though, the manufacturer decided to set the price very high. High enough, actually, that the cookies became a luxury product and were regarded as an attractive, high-status gift. The advantage of that – from the manufacturer’s point of view – was that they could earn quite a bit of money with very little effort. The disadvantage… well, the high price made it very attractive for competitors to enter the market.
But couldn’t they – the original manufacturer – have done something to prevent the new competitor from entering the market?
Yes, they could have – but not with their cookies at that price point.
As a case in point, for several decades, the Danish market for common cooking salt was a monopoly. But even though it is even easier and cheaper to produce salt, than it is to produce butter cookies, nobody else wanted to compete for that market. Why? Because the monopoly set the price so low, there was only very little profit to be gained. Which made the cost of trying to enter the market prohibitive. The salt monopoly was only broken when cooking salts started to be sold as a luxury product – in different flavours and from exotic sources – which raised profits high enough that other companies saw an advantage in competing on that market.
But, back to the cookies. There is a new player in the market, and they are undercutting the old, established monopoly on price. So what do you do, old monopolist? Do you try to underbid them in turn, to try and force them out of the market? Or do you try to differentiate your cookies by some other means – advertising, maybe – even though there really is no perceptible difference in neither taste nor quality?
They decided to go for the squeeze…
In the end, as the dust settled, Danish Butter Cookies were comparable in price to any other cookies on the market – which of course meant, that a lot of people could now afford them (larger market, and thus potentially more demand) – but… they were also suddenly in direct competition with a lot of other cookie products (so actually not much more demand!). And also – it is kind of difficult for a cheap cookie, available in wholesale boxes at discount stores, to maintain an air of exclusive luxury. All in all, probably slightly more cookies were sold than at the beginning of the fray – but earnings per cookie had plummeted. It was a massive self-own.
And that concludes the Tale of Two Cookies. In it we saw enacted the core principle of modern, free-market capitalism: how free competition will work to undermine monopolies and lower prices.
Well, that is one way of looking at it. A bit simplistic and naïve, maybe, but fundamentally true.
On the other hand, you might also read it to say that the monopoly was only broken through incompetence and sheer happenstance. The monopolist was greedy and had set the price very high. Would the competitor have decided to enter the market (always an expensive and risky thing to do when there is an established, major player there already) if the price had been just a little lower?
The free market does not in any way ensure that monopolies are broken. In fact, it does not do very much at all, except create a possibility for other companies to maybe decide to compete. Whether and when and how that happens… well, who knows?
In my upcoming posts, we will continue our analysis of modern-day capitalism and take a closer look at how you can “game” the market and manipulate both demand and price for your products. And along the way, we will learn a lot more about how our society works and the mechanisms by which it is being changed…