A Thought on the Demand Curve

A common argument we hear whenever economic competition rolls around is along the lines of “how can current participants in the market compete with lower prices offered by the newcomers?” This complaint is commonly heard in dealing with international trade or immigration; the fear is if these foreigners are allowed to have their way, they will displace domestic actors with their lower prices.

On the surface, this seems plausible.  Why pay $5 for something you can get for $3?  The sellers would have to bring down their prices.

However, the key assumption in any demand analysis is that the products compared are identical.  A different product may have a higher price than another product and there would be no substitution.  An example of this is what I discussed a few posts ago in regards to baseball.  David Price is under no threat from me by offering my cheaper pitching services because the quality simply isn’t there.

It’s a similar situation with imports (whether it be of labor or capital).  In competitive markets, a good/service’s price is equal to their marginal revenue (in other words, a good/service is priced by the benefit it provides).  If a new product comes into the market at a lower price, it may be because it is of lower quality; it provides fewer benefits.  Such an entrant would pose little risk to an already-established product of a higher quality.

So, the answer to the question posed by trade restrictionists of “how can Americans compete with low-wage workers from China (or Mexico etc), the answer is simple: remain more productive and provide more marginal benefit.  That is the nature of economic progress.