P is for Price

The latest in the alphabet from the NZ Initiative:

From an engineering perspective at least, a good case could be made to use silver for all electric wiring. Silver just makes more sense than, say, copper, steel or aluminium. That is because silver’s specific electrical resistance is the lowest of all metals.

Why we do not use silver for overhead power lines has a lot to do with and the role that prices play.

To most non-economists, prices are just what we pay for the goods and services we buy. To economists, however, prices are much more than that. To them, prices are a marvel, a work of art – or a little less poetically, a very condensed piece of information.

Think about it this way: if the last coffee crop was bad, or if suddenly millions of Chinese developed a craze for double espressos after every meal, the resulting global shortage of coffee beans would not result in rationing. Nor would it require a central planner to tell people to drink more tea instead. What it would do, however, is increase the price of coffee so that coffee drinkers would adjust their consumption accordingly.

Prices bring together everything we know about the supply and demand of any given good. In this way, they help us to decide what to use resources for.

This, then, explains why we do not use silver for all electrical wiring. It is a rare metal with many other potential uses (such as jewellery, in medicine, or in optics). The high price of silver is therefore guiding it towards its highest value use, leaving the job of conducting electricity to other, slightly less suited but much cheaper metals.

In an economy without a functioning price system, we would not be able to make such decisions. We simply would not know which good could be used for what without resorting to trial and error, planning, rationing and waste.

Prices are absolutely crucial for the functioning of the economy. They bring order into a chaotic world of countless goods, services, uses, consumers, suppliers and intermediaries. Without prices, nothing could coordinate all of these.

Politicians play with the price system at their peril. Yet there are minimum wage laws, rent controls, price controls and other ways of distorting prices. Usually introduced with best intentions, these measures prevent markets from working properly.

The price for such interference will be paid by all of us. But that is a price not worth paying.

Next week is quantitative easing, which should be amusing.

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