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Australian Prime Minister Should Ignore Demands for Price Controls

Economics / Austrailia Jan 11, 2008 - 06:15 AM GMT

By: Gerard_Jackson

Economics Now that we have wall-to-wall Labor Governments the question of price controls has once again been raised, particularly with respect to petrol. Although I do not believe for a moment that Prime Minister Rudd intends to imposed price controls I still think it is prudent to remind people that those who cry out for price controls either believe that the laws of supply and demand do not exist or that they are determined by institutional factors, meaning that they vary according to time and place. From this they conclude that prices can be fixed without any harm to the economy so long as account is take of the costs of production.

This thinking — such as it is — leads to the absurd cost-plus principle that states ‘profit' must be calculated as a percentage of cost, regardless of the fact that it is prices that determine costs. What supporters of controls miss is that costs are subjective, not objective. This fact brings us to the concept of opportunity cost, from which it follows that:

1. Costs an only exist in the mind of the actor.

2. Because costs are subjective they cannot be measured or even observed.

3. Being subjective cost can never be realised because what is sacrificed cannot be enjoyed.

4. In keeping with the well-known economic dictum that bygones are bygones, costs always deal with the future and are based on unique anticipations.

4. Cost is ephemeral, i.e., it can only be dated from the moment the decision is implemented; once the sacrifice has been made the cost is sunk.

It should be clear from these fundamental economic tenets that it is impossible for any outside observer or regulator to measure costs. Those who argue otherwise are assuming that controllers would economic insights, knowledge and abilities that are denied to mere mortals.

What controllers would do is examine companies accounting cost records and then set a price by adding a per centage to it. Now it does not really matter whether the regulator uses historic cost or replacement cost as the basis of his calculations. What needs to be borne in mind is the fact that accounting costs only reflect historic costs, money outlays. They do not and cannot reflect the opportunity costs (the value of sacrificed alternatives) that motivated the investment decision because these costs were subjective and ephemeral.

Furthermore, replacement costs are not costs in any meaningful way because they do not entail sacrifice. Once again, bygones are bygones. What all of this makes abundantly clear is that it is impossible for any regulator to ever know what the real costs of production are.

In a free market consumers determine the prices of the factors of production by imputation. Thus it is only what entrepreneurs anticipate what consumers are prepared to pay for a product that determines what will be invested in its production. If demand rises for a product there will be a tendency to invest more in its output and vice versa . This means that factors have to be bid away from other lines of production, which can only be done by paying more for their services. The process of price determination should now be self-evident.

Unlike god-like controllers and their political masters entrepreneurs are not omniscient. Every businessman find himself facing alternative revenue opportunities which he evaluates on the basis of his own knowledge and expectations. Every decision means that the alternatives have been sacrificed. These alternatives are the real costs of entrepreneurial decision-making: but only entrepreneurs can know what these costs are because they are unique to the decision-maker

Money outlays, therefore, are not costs in the economic sense of the word. Costs are forgone opportunities and because these opportunities are subjective they can never be really known to anyone but the decision-maker. This is the real case against price control. That none of this seems to be properly understood — despite the ground-breaking work of the Austrian school and the LSE subjectivists — is a grave reflection on the present state of free market thought in Australia.

By Gerard Jackson

Gerard Jackson is Brookes' economics editor.

Copyright © 2008 Gerard Jackson

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