As previously discussed in this Foundations of Economics series, economic competition is the process of establishing who produces what in our division of labor economy. Through economic competition, millions of individuals decide in commercial transactions who best utilize our limited resources to produce wealth and the best process for producing that wealth. In other words, our tools for creating wealth (savings, capital, and labor) can be used for alternative applications, and economic competition determines the best applications. For example, a person can use his time and resources to plant and grow apples or he can alternatively plant and grow bananas, but he cannot do both at the exact same time. Consequently, economic competition must be able to accurately measure success in the marketplace to determine the best use of our tools for creating wealth. So how do we measure success in economic competition?
Success in economic competition is measured through prices and the profit and loss system formed in the marketplace.
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Most people have a basic understanding that prices are established through the relationship of supply and demand. However, it is not commonly understood that the price system provides a vital role in coordinating the production of wealth. Everyone makes economic decisions based on the consideration of prices both as a buyer and a seller. For example, a potential car buyer will determine which car to buy by comparing different car prices. When a student determines her career plan she usually evaluates the difference in income expected to be earned in different professions. And businesses make their decisions based on profit-and-loss calculations.
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Each of these decisions is based on an adjustment to the plans of others in the market place. It is the willingness of others to pay more or less for a vehicle that determines the relative price of cars for the potential car buyer. It is the willingness of people to pay more for a particular service that determines the salaries of the various professions considered by the student. Finally, it is the desires of potential consumers and the decisions of business competitors that form the prices of goods that determine what is profitable for the business to produce. Thus, the market’s price system integrates the plans of each unique individual with the plans of all other individuals and thereby coordinates a rationally planned economy for producing wealth.
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Similarly, the profit and loss system also organizes the production of all our needed wealth in the market place. Businesses and entrepreneurs will produce anything for which they believe consumers will pay a profitable price and stop; they will stop producing things for which consumers are unwilling to pay a profitable price. Thus, the concern for profits prevents continued mistakes in the overproduction of some things and the underproduction of other things. For example, assume a business or multiple businesses make a mistake by investing too much capital into producing apples instead of bananas. The consequence is that the excessive amount of apples suppresses profits in the apple industry because the excessive amount of apples can be sold only at lower prices. Conversely, the underinvestment in the banana production raises profits in the banana industry because the deficient amount of bananas raises their price. Thus, the very mistake in overproduction of apples creates incentives for its correction.
Moreover, the profit and loss system creates the very means for correcting mistakes in the marketplace. The higher profits in the banana industry, resulting from the underinvestment in their production, become the very source of additional capital invested in the industry. On the other hand, the decreased profits in the apples industry removes the very means to continue the overproduction of apples. Therefore, mistakes made in the relative production of various goods are quickly self-correcting, thanks to the existence of profits and losses in the market place.
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Some politicians, like President Obama, will denounce the existence of prices and profits as immoral or unnecessary in tough economic times. Similarly, other politicians, like President Bush, will declare that a sudden failure in the marketplace indicates that the profit and loss system is not functioning properly. In times of economic distress, however, prices and the profit and loss system accurately and honestly direct resources to the most efficient production of needed wealth. Government interference or manipulation of profits and prices further harms the well-being of an economy already in distress. Market-set prices and the profit and loss system are vital during times of economic distress so the production process can meet our need for wealth.
In every economic system, our various resources with alternative uses must be directed into the production of wealth demanded by millions of unique individuals. If the production process is not guided by prices and a profit and loss system, a central planner must insert itself in the place of the millions of people making decisions on their own behalf. Of course, a central planner is incapable of having knowledge of what millions of unique individuals want and need. Thus, when the government enters into the marketplace, it distorts the very synchronization of millions of unique individuals made through prices and the profit and loss system. Much like a broken cellular tower, when the government interferes with prices and the profit and loss system it shuts down communications between millions of individuals in the market place. Government interference therefore isolates men and forces them to lift themselves up by their own bootstraps rather than coordinate with individuals in a division of labor economy. It is the very interference of government in the economy that leaves every man for himself.
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John Langenderfer is a practicing attorney with a focus in consumer and commercial law. He can also be reached on his Facebook page.
All opinions expressed belong solely to their authors and may not be construed as the opinions of other writers or of OCR staff.