High Costs and Low Costs

All production requires costs; all output requires input.  To that end, costs (which we will refer to here as the economic resources, namely land, labor, capital) are essential.  We free-marketers, in promoting our cause, will sometimes be glib on costs and argue that free trade will reduce costs (that is, reduce the amount of resources necessary) to produce.  But yet, here in the United States (and elsewhere), as we expanded trade we’ve used more resources.  More labor is used in the US than in past decades and centuries.  More land, more capital.  And, indeed, the rates those resources command have risen.  Wages are high.  Rents are high.  Are we wrong?  Are the protectionist worries of joblessness and ruin overblown?

Here, we return to our supply and demand diagram.  Such a simple picture, but it tells us much:

supply-and-demand-graph

A rise in price (that is, an increase in costs) can occur for two reasons: 1) An increase in demand (the demand curve shifting to the right) or 2) a decline in supply (the supply curve shifting to the left).  Both these shift result in higher costs, but the reasons are staunchly different.  One is desirable, the other is detestable.  An increase in demand is a sign of increasing welfare: people have more to spend on various goods and services.  This increased competition for goods raises prices, which generates more production.  Firms, reacting to these higher prices, increase their inputs: they hire more workers, invest in more machines, build more factories.  The wage rate and rental rate increase; the prosperity causes the firms costs to rise.  Prices are higher, yes, but so is the standard of living.

But what happens in the opposite manner?  If the supply of a good is cut, then price rises but production is reduced.  Although prices are high, firms are not looking to expand production; resources are scarce.*

The price rises are caused by two separate things.  Whereas the first (demand-shift) is caused by abundance, by wealth, the second (supply-shift) is caused by scarcity!

It is also true in the opposite manner: prices can fall because of abundance in supply (supply curve shifts to the right) or scarcity in demand (demand curve shifts to the left).

Protectionists often tout the higher prices their policies will bring as a good thing: they will grant the firm more profit and thus higher demand for workers and higher wages, they promise.  But they confuse the effects of their policies.  They implicitly argue their policies create higher prices because of an abundance of demand, but it is really because of a scarcity of supply!  This stands in stark contrast to the higher prices that develop from free trade, from the abundance of demand.  This is also why wealthy nations tend to have higher prices (in nominal terms) than poorer nations.

Once again, we see the protectionists arguing the most absurd notion that it is in scarcity we grow strong and abundance we grow weak!

*I am quick to add that, for the sake of our conversation, I am assuming the shortage-driven price is not causing others to look for alternative methods to supply the demand.  This assumption is not true, but it simplifies the discussion.  Relaxing this assumption does not change the outcome discussed.

One thought on “High Costs and Low Costs

  1. I can hear the protectionists now: “But, more spending on American products, puts more dollars in American workers’ pockets thus causing greater demand and eventually greater supply.

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