You Buy From Other Consumers, Not From Producers

Michael Munger

If you want something, you are usually buying from other potential purchasers, not the owner. Failing to understand that leads us to adopt wrong-headed policies such as anti-gouging laws, rent controls, and attempts to reduce inflation with price planning.

We’ve known this truth for centuries. A famous example, Diocletian’s “Edict Concerning the Sale Price of Goods,” was apparently intended to hold down prices simply by forcing sellers to ignore the fact that someone else wanted to pay more than the buyer now in front of them. The economic reasoning for why this is a problem was clearly laid out by Eugen von Böhm-Bawerk in his widely cited (but largely unread) book, The Positive Theory of Capital.

It is worth quoting Böhm-Bawerk at length, to understand the point:

A peasant, whom we shall call A, requires a horse. His individual circumstances are such that he attaches the same value to the possession of the horse as he does to the possession of £30. A neighbour, whom we shall call B, has a horse for sale. If B’s circumstances also are such that he considers the possession of the horse worth as much as, or worth more than £30, there can, as we saw, be no exchange between them.

Suppose, however, that B values his horse at considerably less, say at £10…[E]ach of the contracting parties can make a considerable profit by the exchange. If, for instance, the horse changes hands at £20, A makes a profit of £10, and B gets £20 for an article worth only £10 to him…

How high will this price go? As to this it may be said definitely: The price must at all events be less than £30, otherwise A would have no motive for going on with the exchange. And it must at all events be higher than £10, or there would be no use in the exchange to B, and perhaps even loss. But the particular point between £10 and £30 at which the price will be fixed cannot be determined beforehand with certainty…

There is no difficulty in putting this briefly in the form of a general proposition. In isolated exchange—exchange between one buyer and one seller—the price is determined somewhere between the subjective valuation of the commodity by the buyer as upper limit, and the subjective valuation by the seller as lower limit.

Well, there it is. In many of the transactions that take place in plausible circumstances there is no determinate price, but a tendency for price to “move toward equilibrium,” because the transaction’s resolution will depend on idiosyncratic factors.

Of course, the point of markets is the elaboration of division of labor, which creates increasing returns over a substantial range as the extent of the market is expanded. A seller in a production environment characterized by division of labor will have just one widget to sell, but many, many copies of that widget. How is the price determined then? It is tempting to think that the notion of equilibrium price can now be applied.

But Böhm-Bawerk recognized this next step, and solved the problem of how price is determined. And his analysis reveals a fact that I believe is either completely forgotten, or underappreciated. In effect, when someone buys something in a market setting, they are not buying from the producer. Instead, consumers buy from other potential consumers.

Consider Böhm-Bawerk’s discussion:

Let us assume that [consumer] A1 finds a competitor, whom we shall call A2, already in the field, and [A2 values the horse at] £20. What will happen now? Each of the competitors wishes to buy the horse, but only one, of course, can buy him…Each, therefore, will try to persuade B to sell the horse to him, and the means of persuasion will be to bid a higher price….

So long as the bids are under £20, A2, acting on the motto “rather a small gain than no exchange,” will try to secure the purchase by raising his offer, which attempt, naturally, A, acting on the same principle, will counteract by raising his offer. But A2 cannot go beyond the limit of £20 without losing by the exchange. At this point his advantage dictates “better no exchange than a loss,” and he leaves the field to [A1].

Many people might argue that I should not use something that someone else values more, but that it would be a morally good act to leave the scarce item for others. In the case of consumer products, this means that I leave some for the person behind me in line, or the person who will come in this afternoon and really needs that item. It is in this setting that laws against “price gouging” are ignoring Böhm-Bawerk’s insight in a harmful way. As I have argued before, the problem with anti-gouging laws is that we are encouraged to see only the producer and the producer’s cost in deciding what a fair price should be.

During the summer of 2020 there were shortages of toilet paper around the U.S. In several states, anti-gouging laws were used to prosecute sellers who charged “too much” for toilet paper. But think of it from Böhm-Bawerk’s perspective. The high prices were “bids” from people who had not yet made it to the store, but who wanted toilet paper. If I see a low price of toilet paper, it tells me that no one else needs toilet paper, and I should fill up my basket (this is not hypothetical; people actually did buy dozens or even hundreds of rolls of toilet paper in states with anti-price-gouging laws!)

But the price mechanism, if it is allowed to operate in situations of scarcity, allows other consumers to “bid” against the person who is thinking of hoarding. If prices are allowed to rise and carry out their proper function, then the current purchaser is really buying from potential future purchasers. Other consumers who will arrive later today, or tomorrow, are given a fair chance to “try to persuade the seller to sell the [toilet paper] to them.” It is better to give others a chance to bid on scarce items, because having the product available at a high price is better than empty shelves. Likewise, higher rents are better than having no housing available.

The only way to do that, however, is to recognize that other consumers, not the seller, are responsible for the prices charged. Attempts to “manage” or “plan” prices do nothing to address the real problem of scarcity, and often make scarcity worse. Price controls are a restriction on the ability of other consumers to have their needs met, and that’s just wrong.

Courtesy: (AIER)