Book: So Many Economic Myths . . . where do I begin?
It's amazing how often I feel the need to say out loud "well, that's just plain wrong" to the TV nearly everyday (yeah, it's a little crazy, I know). But, news pundits drive me nuts talking about "overpriced" cars and "obscene profits," for example, defying basic economic concepts.
Want to know why such descriptions are incorrect (or impossible)? Below I've posted Chapter Four (at no cost to you!) of my book The Common Sense behind Basic Economics, which attempts to debunk many of the common myths and assertions that are frequently made in the media. So frequently are these myths promulgated that most of us just accept that they must be true, otherwise why would everyone be saying them - over and over, and over? Well, just because we keep repeating them, doesn't make them any more correct.
In the passage below, I hope to provide a few examples of why you should believe me . . . and not them.(FYI: You can order a copy of The Common Sense behind Basic Economics from Lexington Books now at a 30% discount. Enter code LEX30AUTH16 at checkout.)-----------------------------
FOUR
Man, That Ain’t True
One of the reasons I decided to write this book was to correct the massive amount of misinformation that many hold dear. These economical myths can be found in every news and web source, so much so that people cite “trusted” news websites or programs as the reason why they believe a particular myth to be true, without even realizing how wrong even the most reputable of web information can be. It’s kind of like relying on a career criminal to give an honest answer to “what really happened that night?” He’s probably so used to presenting a “misinterpretation of the facts” that he doesn’t even know the truth any more.
The following are just a few examples of myths that keep walking the talk show circuit, pervading public office seekers’ speech, and even sometimes enter the know-it-all world of academia.
SILLY MYTH #1:“Prices are unfairly manipulated by greedy profiteers who take away from the people who really deserve it.
”Prices are always two-sided. An entrepreneur won’t sell goods and services if someone on the other end doesn’t value what is being sold at the price it is being sold. If agreed upon, they must find the transaction mutually beneficial, or else it just won’t happen. Given a perfectly free and competitive market, prices will always fall to the lowest price at which an item can be sold where the seller can still make a profit. Otherwise, the seller will lose business to a competitor and eventually go bankrupt.
Of course, the previous paragraph has a couple of assumptions. First, mutual agreements don’t necessarily occur when, for example, a store clerk pulls a gun on a customer, forcing him or her to accept his price. (This isn’t a business management book and I’m not going to tell anyone how to run their business, but this is generally considered poor customer service.) In addition, perfectly free and competitive markets don’t always . . . well almost never, exist. For the most part, however, this theory holds and will be explained more thoroughly in subsequent chapters. And lastly, and quite amazingly, competition can sometimes be so fierce as to force prices to fall below profitability in the short-run. There are any number of modern cases where sellers have reduced prices so far that they take a loss, just to be the most competitive, increase or maintainmarket share, or to push out or keep out competition. They can’t do this with all of their products in the long-term, but sometimes competition makes this happen. I don’t care as long as I get the best price I can get.
SILLY MYTH #2:“Government is the only one that can fairly control the market and prices.”
If you believe prices are merely “manipulated” by capitalists, you might also think that the only solution is a government one. When governments try to manipulate prices, however, they often fail to consider the true costs, which cannot be changed via policy, executive order, or even government fiat. As seen in housing, medicine, etc., when prices are artificially maintained low, producers either stop producing (as investments also tend away from these industries) or quality will be affected in order to increase profitability.
Sometimes you’ll hear our legislators say something about a business’ usage of “predatory pricing,” substantiating their argument for a more visible hand in the economy. Nobel-prize winning economist Gary Becker said it pretty well, “I do not know of any documented predatory pricing case.” Predatory pricing, under its most common definition, is when one firm sets the prices of its products so low that no one else can compete, causing all potential competitors to leave the market while also blocking other potential competitors from entering.
Predatory pricing is a myth that hasn’t translated to reality and won’t because it is too risky to invoke. If a company reduces its prices to a point at which no potential competitor can compete, they will lose money until competition temporary leaves the market. There is no way of knowing neither how long this strategy will take nor how much it will cost. The only way to ensure a new competitor doesn’t enter the market replacing the old one is to maintain price levels at the loss-producing level. Otherwise, some entrepreneur will see an opportunity to buy up the remnants of the previous competitor and produce the same good or service more efficiently than the one that left (which is easier to do with the bankrupted company’s discounted assets). A “successful” predatory pricing strategy will only result in bankruptcy.
In addition, anti-trust laws are pretty tough. Just ask Microsoft, who unsuccessfully tried to drive out the competition and create a monopoly for one of its products. The government sued, Microsoft lost. Life, and competition, moved on. In another case, Google is now being sued in Europe (as of the writing of this book) for a seemingly far less egregious attempt to block out competition with its free online services. While back in the U.S. telecommunication companies are the targets du jour at the Federal Communications Commission (FCC), which seems to be in constant discussions about companies’ price structures, potential mergers, and market power. The effects on even publicly traded behemoths maybe minimal, but it goes to show how governments go out of their way to ensure that “predator” pricing never takes place and is unlikely to ever be a winning strategy . . . and companies know it.
SILLY MYTH #3:“Brand-named goods are overpriced and rip off consumers.”
Yes, those Balmain “painted-denim” designer jeans are extremely overpriced(retail 1,888 dollars), well, per my highly subjective opinion. So, why are they so popular that people keep buying them when you can buy a pair of perfectly good Wrangler jeans at Wal-Mart for an old picture of Andrew Jackson? Companies with so-called “overpriced” brands are able to sell their goods and services at higher prices because we attribute more value to those brands.
Let’s compare a generic drink from an off-brand gas station’s fountain soda machine to a bottle of Coca-Cola. The generic soda is .40 cents cheaper for the 64 ounces of carbonated pleasure, and you might not taste the difference, so you can’t help but consider it. However, you don’t know that will be the case before you try it. When you’re in a small town a thousand miles away from home and you want something that tastes exactly like the Coca-Cola you’ve been drinking since you were a kid along with a guaranteed standard of quality, you might choose not to risk it on another brand and instead decide to just stick to Coca-Cola, even at a higher price.
In addition to trusting our brands of choice, consumers also feel “insured” by a brand created by a company that has assets. Say you drink that gas station-made fountain drink and find that the owner “accidentally” spilled antifreeze in it, which makes you crazy sick. Even if the gas station is highly successful, the owner might not have the means to fully compensate you for your medical bills or loss of work. With around seven billion dollars in annual profits, Coca-Cola would probably cough up a lot of dough to compensate you for their mistake (as well as to keep you good and quiet about it). You might, therefore, consider that extra money spent on a Coca-Cola Classic a worthwhile insurance plan.
SILLY MYTH #4:“There is no reason for an entrepreneur, or corporation, to make such obscene profits.”
Entrepreneurs—who can be a mom in their garage as much as a rich CEO of a Fortune 100 company—continue to successfully grow ventures and reinvest profits because of the potential reward of continued and greater profits in the future. They hire workers, invest in buildings and equipment, purchase resources, research, and develop all at their own expense, long before receiving the benefit of their investments, simultaneously and continuously risking that it will all be for nothing or that they will have stress-related heart attacks before they see any profits. Yeah, it takes a special person to voluntarily undertake this line of work with such historically-poor risk-reward ratios (some studies show that more than 80 percent of these new ventures fail).Given the risk of complete failure and financial loss, the potential for profits has to be high enough to impel an entrepreneur to action. Investments tend towards those industries which are growing rapidly due to high consumer demand because of the potential for huge rewards. But risks tend to also be higher in growing industries due to increased competition. The next time you’re concerned about “outrageous” corporate profits, consider what your life would be like without mobile apps, or the internet for that matter, both of which have grown and developed due to the high returns that investors require. For some, it pays off and they earn their reward, which begets more investment, more apps, and better technology that we all enjoy . . . all thanks to the wonder of profits. For most of us though, we’d rather work for a large business or government that provides a nice set of benefits and a cushy 9-to-5. There’s nothing wrong with that, just keep in mind what it takes to become a successful entrepreneur, and you might have a little more respect for their “obscene” rewards.
SILLYMYTH #5:“Trickle-down economics doesn’t work.”
Actually, this silly person would be right. That’s because “trickle-down” economic theory doesn’t exist. Political strategists made up this term many moons ago to suggest that economic policies that provide greater long-term incentives to entrepreneurs don’t work. According to them, advocates of free-market, low-tax, minimal regulation policies expect that the immediate profits made by rich people at the top will “trickle-down” to us mere peons at the bottom of the economic ladder.
But, that’s not what supporters of a more free economy think will happen at all (unless they’re wrong). In fact, profits don’t come until after significant investment is made in research and development, machinery, expansion, marketing, new employees, and time (most often years, see previous discussion about the risks of entrepreneurship). Only then do employees and other Americans who benefit from the products and services created by these investments begin returning the favor by themselves purchasing goods and services, which only then provides the profitable returns anticipated in the first place. Unfortunately, for you budding entrepreneurs out there, you don’t get to benefit first before the rest of the economy does. You better show us that we need you for a while before we reward you for your creation. The profit time delay on investment is the reason that so many market incentives are needed to boost entrepreneurship. Those incentives shouldn’t be seen as a hefty bonus to those who already have all the money. They are anything but.
If you ever hear someone dismiss such policies as “trickle-down,” challenge them to find a single economist in the history of economics who has advocated for it (hint: you’ll win).
SILLY MYTH #6:“Socialism isn’t so bad. Perhaps we just need to give it another chance. It just wasn’t done right before.”
Socialism, communism, Marxism, feudalism, etc., etc. have never, ever, ever, ever worked. I define “worked” as helping the economy to grow and prosper in the long-term. Those bureaucrats and feudal lords at the top might very well argue that these systems work perfectly fine! People often try to refute this by giving the examples of China, Canada, or some European country that has some socialistic attributes. China’s success (if by success you mean per-capita GDP less than half of our government’spoverty level, then I suppose you can call its economy “successful”) has only recently come as a result of the freeing of its economy, whereas mostEuropean economies that have more socialistic tendencies have been declining relative to the rest of the world for some time, and now have veryslow-growing, or shrinking, economies and far worse unemployment than our relatively freer economy.
Why haven’t socialist economies ever worked, nor will they ever? Trying to manage “the market” efficiently is an insurmountable task. Millions of pricing decisions are made every day between consumers and sellers that no number of bureaucrats could efficiently manage, even if they had the motivation to do so. We’re motivated by finding deals andmaking money, which makes it easy for each of us to manage our own piece of the economy. Imagine if you had the job of making every one of those decisions for everyone, but would be paid whether you did it well or not? You’d probably take a lot more breaks than you do now and probably wouldn’t care too much whether thousands of those decisionswere poorly made. That’s exactly what leaders of the U.S.S.R. figured out, just a tad too late.SILLY MYTH #7:“We can tax businesses to raise tax revenue to support the policies we want to enact, without hurting any individuals.”Amazingly, some of the smartest among us truly believe this one.When a legislator tries to pass a tax on businesses, using the argument that itwon’t be a tax on any particular group of people, they either don’t know what they are talking about, or are making a “strategic misrepresentation.”Just because the law directs a business to write the check to Uncle Sam, doesn’t mean a business is going to sit back and take one for the team, watching its net income shrink.Business owners can pass off those costs to consumers, if the market allows, or, more likely, will make cuts in-house. The latter often results in employees being relieved of their duty or taking pay, or more likely, benefit cuts. Even if the business owners think it best to eat the costs, keep in mind that business owners are people too. In fact, most large,publicly-traded companies (the more frequent targets for such taxes) areowned by pension, mutual, and insurance funds whose owners are teachers, businessmen, mid-level managers, bureaucrats, factory workers, and every other type of American.Businesses do not pay taxes, people do.I could fill another book with even more of the silly myths that are ruining future economists’ minds (hey, an idea for a spin-off?), but these are just a few of my favorites. Most of the many misunderstandings you’ll hear can simply be dispelled with a basic understanding of the basics of economics.----------------------You can order a copy of The Common Sense behind Basic Economics from Lexington Books now at a 30% discount! Enter code LEX30AUTH16 at checkout.