The Price is Always Right

Last night I dreamt that I lived in a world parallel to ours, in Old Cork City in the Stated Unions of Columbia. The Columbians are an affluent and enlightened lot, but they suffer from a very peculiar madness: they consider Newton’s laws of motion and gravity to be ethically unjust and refuse to abide by them. It is clear to every Columbian that light objects soar while heavy objects must crash to the ground. Yes, scientists at Old Cork College have repeatedly shown that feathers and a bowling ball fall at the same speed in the absence of air resistance, but Columbians figure that gravity works differently in a perfect academic setting than it does in real life.

Since it is unfair for heavy things to fly while lighter objects are earthbound, heavier than air flight is banned in the SUC. Airlines are allowed to increase the weight of their zeppelins by no more than 5% from year to year, an arbitrary number arrived at after consultation with astrologers.

There are physicists in the Stated Unions, and their journals are full of lift equations and orbit calculations. Columbians have learned to ignore their physicist’s incessant calls for airplane and rocketry development, and their admonitions that starvation will not help man to soar. It’s quite obvious that a physicist’s job is to argue over string theory and quantum interpretations, flight is a simple, common sense issue, one that the public can handle quite well without the aid of experts. A few Columbians each year diet to near starvation and then jump off cliffs hoping to fly, but their numbers are small enough not to put any politician’s career in jeopardy.

In 1903, two Columbian bicycle repairmen named Orville and Wilbur Rong built an illegal airplane in secret. From a field outside the town of Puppy Eagle the brothers soared into the cold December air. For three seconds the only sound heard was the whine of the propeller and the rush of wind on the wings. Then, the sound of gunfire filled the air as state police promptly shot the Rong Flyer from the sky. The gathered public erupted in applause at the resolute reaction of law enforcement.

In my dream, I wondered at my countrymen’s reluctance to acquiesce to the simple laws of nature. Perhaps people rebel against the idea of a system beyond any person’s design, one that doesn’t follow any person’s wishes but imposes its implacable rules on all men. Perhaps the Columbians just need more time to come to grips with Newton’s formulas. After all, they were only published as late as 1687, barely three centuries prior.

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In 1695, eight years after Newton’s Principia, English philosopher John Locke published a very short essay called Venditio, concerning pricing and the ethics thereof. Wasting no time, Locke kicks off by explaining the Law of One Price in an open market (emphasis mine):

Upon demand what is the measure that ought to regulate the price for which anyone sells so as to keep it within the bounds of equity and justice, I suppose it in short to be this: the market price at the place where he sells. Whosoever keeps to that in whatever he sells I think is free from cheat, extortion and oppression, or any guilt in whatever he sells, supposing no fallacy in his wares.

To explain this a little: A man will not sell the same wheat this year under 10 Shillings per bushel which the last year he sold for 5S. This is no extortion by the above said rule, because it is this year the market price, and if he should sell under that rate he would not do a beneficial thing to the consumers, because others then would buy up his corn at this low rate and sell it again to others at the market rate, and so they make profit off his weakness and share a part of his money. […]

But if it be said ’tis unlawful to sell the same corn for 10S this week which I sold the last year for week for 5s because it is worth no more now than it was then, having no new qualities put into it to make it better, I answer it is worth no more, ’tis true, in its natural value, because it will not feed more men nor better feed them than it did last year, but yet it is worth more in its political or marchand value, as I may so call it which lies in the proportion of the quantity of wheat to the proportion of money in that place and the need of one and the other.

Locke understood that when you come to a city with many buyers and sellers, and they all sell and buy wheat from each other at 10S, the only price you can sell (or buy) wheat at is 10S. Moved by some intuition of fairness you may want to sell it at last year’s price of 5S, but you can’t. Whoever buys it for 5S will immediately resell it for 10S to those who will actually consume it, you have simply given your profit away to an unproductive third party. You may want to sell your wheat for 20S because you’re greedy, but you can’t. No one will buy for 20S what they can get next door for 10S.

A single market will have the same price across it for a single good or service. What defines a single market is a group of buyers and sellers that are easily replaced by one another. That’s why the price of wheat in a shop down the street matters: the buyer can easily go there and get that price. That also why last year’s, or even yesterday’s, price in the same shop doesn’t matter: neither the buyer nor the seller can travel to yesterday and buy yesterday’s tomatoes at yesterday’s price. The price of tomatoes on Mars is more relevant to the tomato market in London than the price of tomatoes a week before; Mars is at least in principle available to trade tomatoes with.

Like Newton’s first law, which states that an object will not change its motion unless acted upon by a force, the Law of One Price is counterintuitive for the first 10 minutes of pondering it. At that point, it becomes so deeply obvious that one is shocked at how humans have lived for millennia without grasping it. Unfortunately, 10 minutes of thought are beyond the abilities of journalists and politicians to this very day.

The Guardian:

Burning Man tickets will be even more expensive this year thanks to a new Nevada entertainment tax that the state is requiring the festival to impose.

The price for the majority of tickets to the massive summer event in the Black Rock Desert, three hours north of Reno, has climbed from $390 to $424 for an individual ticket due to a 9% state tax that organizers have unsuccessfully tried to fight over the past month.

Quick, children, what’s the real price for Burning Man 2016 tickets, $390 or $424? The answer, of course, is that the only price of Burning Man tickets is exactly $840, that’s the price at which they are resold to the actual festival attendees. Burning Man organizers can keep a larger or smaller chunk of the $840 to themselves by raising or lowering the price, the state of Nevada can keep more or less of the $840 by changing the tax, but neither of them sets the price of $840.

Without nitpicking, let’s say that there are 70,000 tradable tickets available for Burning Man. The price of $840 is the only one at which exactly 70,000 people want to buy a ticket. Without changing the capacity or desirability of the festival, the only thing Burning Man organizers do by moving the price is deciding how much money to donate to Stub Hub and the resellers. They could have donated that money to poor attendees by giving some of them non-transferrable free admission (they do a little of it). They could have donated that money to charity. Instead, they simply donate 70,000 * $400 = $28,000,000 to ticket resellers for no good reason whatsoever. Hamilton on Broadway is donating $12,500,000 a year.

Jumping off a cliff and hoping to fly.

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Of course, you may say, there are free markets and then there are hurricanes. When hurricane Sandy hit the tri-state area in 2012, many gas stations lost power and people at first were willing to pay $20 for a gallon of gas that cost $4 the week prior. This is such a novel and unusual situation… that John Locke described it with perfect precision 317 years prior:

To have a fuller view of this matter, let us suppose a merchant of Danzig sends two ships laden with corn, whereof the one puts into Dunkirk, where there is almost a famine for want of corn, and there he sells his wheat for 20S a bushel, whilst the other ship sells his at Ostend just by for 5s. Here it will be demanded whether it be not oppression and injustice to make such an advantage of their necessity at Dunkirk as to sell to them the same commodity at 20s per bushel which he sells for a quarter the price but twenty miles off? I answer no, because he sells at the market rate at the place where he is, but sells there no dearer to Thomas than he would to Richard. And if there he should sell for less than his corn would yield, he would only throw his profit into other men’s hands, who buying of him under the market rate would sell it again to others at the full rate it would yield. […]

Dunkirk is the market which the English merchant has carried his corn, and by reason of their necessity it proves a good one, and there he may sell his corn as it will yield at the market rate, for 20s per bushel.

Locke is correct that on a first order analysis, selling the corn (grain) at 5S in Ostend or 20S in Dunkirk are morally equivalent. If we also consider the effects of supply and demand, we can see that the ethical obligation is for the merchant to take his grain to Dunkirk, as his arrival there will help the neediest and immediately reduce wheat prices. The price of 20S is driven by the tiny supply of wheat available, even a single ship will increase that amount enough for the price to drop.

If New Jersey gas stations were allowed to sell gas at $20, the price would have stayed at that level for at most 3 or 4 hours. That’s how long it takes to fill up a tanker in Pennsylvania or Maryland and drive to Jersey. Who would be the suckers buying at $20 in the first few hours? Perhaps a doctor who must commute to a hospital where a single hour of her work is worth hundreds of dollars and the lives of patients.

New Jersey law prohibits “unreasonably excessive” raising of prices. In a state where fashion boutiques change the prices of jackets by 80% day to day on a whim, “unreasonably excessive” increases in the price of gas in a once-a-decade storm turned out to be 5%-10%. That number was arrived by lawyers setting precedents in courts, no one bothered to consult economists. Everyone knows that the job economists is to debate the impact of monetary policy on labor productivity in obscure journals. Prices are obviously a common sense issue that the public can handle quite well without the aid of experts.

Professor Locke, can you predict what happens when price “gouging” is capped at 5 or 10 percent:

Besides, as there can be no other measure set to a merchant’s gain but the market price where he comes, so if there were any other measure, as 5 or 10 per cent as the utmost justifiable profit, there would be no commerce in the world, and mankind would be deprived of the supply of foreign mutual conveniences of life. For the buyer, not knowing what the commodity cost the merchant to purchase and bring thither, could be under no tie of giving him the profit of 5 or 10 per cent, and so can have no other rule but of buying as cheap as he can, which turning often to the merchant’s downright loss when he comes to a bad market, if he has not the liberty on his side to sell as dear as he can when he comes to a good market. This obligation to certain loss often, without any certainty of reparation, will quickly put an end to merchandising.

What does it look it like when the “obligation to certain loss puts an end to merchandising”? It looks like a state where gas stations have gas in the ground, but no power in the grid to run the pumps. Many gas stations had generators that would power the pumps, but running the generators costs more than electricity from the grid does, and without raising prices by more than 10% that gas stations couldn’t break even while running generators. In case this isn’t clear: there is gas in the ground, there are pumps to pump the gas, there are generators to power the pumps, there are people desperate to buy the gas, there is a law that prevents them from doing so, there is someone dying in a hospital because their doctor can’t get there to help them.

But, it turns out that there weren’t enough people dying in hospitals to put governor Christie’s career in jeopardy.

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A lot of people when they read The Rationality Sequences are rankled by Eliezer’s insistence that irrationality isn’t an inconsequential issue, but that almost everybody in the world is insane almost all of the time. A counterargument to Eliezer is that people have crazy beliefs when they don’t actually pay for having them. A person who disbelieves the multiple world interpretation of quantum mechanics suffers no worse harm than Eliezer’s stern disapproval. Holding crazy political views doesn’t cost a single person on the margin, since one person’s vote never counts.

The counterexample to that argument is this: they clapped.

Hurricane Fran hit North Carolina in September 1996, leaving part of the state without power in 92 degree heat. Food, baby formula and insulin were spoiling in idle refrigerators, and there was no ice to be found within 30 miles of Raleigh, NC. Fortunately, there was ice to be found 50 miles away from Raleigh in the city of Goldsboro, where four young entrepreneurs loaded two trucks with $1.75 bags of ice and drove to Raleigh. On the way, they used chainsaws to clear the road of fallen trees for themselves and for other grateful drivers.

The trucks parked in downtown Raleigh and began selling the bags of ice at $8 a pop, which almost no one refused to pay. As the line of Raleighites yearning for ice lengthened, the local police arrived at the scene to arrest the ice sellers and take the ice away, at gunpoint, from the people who desperately needed it, who had food and baby formula and insulin spoiling in the fridge. And many of these same people erupted in applause at the resolute reaction of law enforcement.

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This morning, I woke up from my dream, and for the few seconds before I remembered I lived in New York and not Old Cork, I was smiling. Zeppelins aren’t so bad: the drinks on board are better and there’s more legroom. But when people fight the law of prices, there are no winners, only losers.