Stop Pretending Price Inflation Is a Result of “Too Much” Profit
Some commentators attribute the latest sharp increase in the Consumer Price Index to businesses pushing prices of goods higher in order to secure higher profits. (See the New York Times article “Democrats Blast Corporate Profits as Inflation Surges,” January 3, 2022). Note that the yearly growth rate of the Consumer Price Index jumped to 6.8 percent in November 2021 from 1.2 percent the year before. However, is it true that businesses are determining the prices of goods and services?
How Prices Are Established
As a rule, a supplier sets the price. After all it is the supplier who offers the goods to the buyers. So it is the supplier who must set the price of a good before he presents the good to the buyers.
In order to secure the price that will improve his lot, the price that the supplier sets must cover his direct and indirect costs and provide a margin for profit. By setting the price, the supplier must make as good an estimate as possible regarding whether he will be able to sell his entire supply at the price set.
The process of making the estimate involves the assessment of the possible responses of the buyers and the possible responses of his competitors—other suppliers. If his estimates are accurate, then he makes a profit. By making a profit, the supplier expands his pool of resources, which in turn enables him to attain more ends. His standard of living improves.
Observe that while the cost of production in some cases would appear to be the main factor in price determination, this is not so. Ultimately, it is the evaluation of the buyer that dictates whether the price set by the supplier is going to be realized. Every buyer decides in his own context whether the price paid for a good betters his life and well-being.
If the cost of production were the driving factor behind setting market prices, then how can we explain the prices of goods that have no cost because they are not produced—goods that are simply there, like undeveloped land?
Likewise, the cost-of-production theory cannot explain the reason for the high prices of famous paintings.
According to Rothbard, “Similarly, immaterial consumer services such as the prices of entertainment, concerts, physicians, domestic servants, etc., can scarcely be accounted for by costs embodied in a product.”1
It follows then that businesses striving to make
Article from Mises Wire