My wife recently picked up an iPad 3.  It’s a wonderful machine – lightweight, with an HD screen, remarkably fast, with literally millions of apps available.  But I’m not a technically smart person, so I am amazed at something quite different; namely, I am amazed at how cheaply one can buy an iPad 3. 

Depending on the options you want, you can pick up the latest version of the iPad for anywhere between 500 dollars and 800 dollars.  That is a remarkably inexpensive price for a machine that delivers incredible capability to the palm of your hand.  I can’t help but think of my first laptop – that “revolutionary” device cost me 1,600 bucks and could do very little in comparison. 

You get the idea – somehow Apple (and a lot of other companies) continues delivering better products, cheaply to the American people. 

This is not an article on the wonders of technology, but rather the indispensable and wonderful role of prices in a free market. 

Note – Apple did not deliver hand held devices because Congress mandated that they do so.  There was no joint session to discuss ways to make the prices lower for the tablet consumers.  Furthermore, there were no executive orders or campaign speeches pointing out how important computer tablets are to our productivity and competitiveness.  Similarly, the President never asked congress to buy iPads for citizens, or create a low-interest loan system for iPads, nor did he deride the huge profits that Apple is making every year selling these devices to people.

Price – the critical messenger of the economy

A free market is an amazing organism when you stop to think about it.  Every day, millions of pieces of information are transferred between producers and consumers.  Information about the availability of raw materials, the cost of production (power supply, labor costs, etc) are transmitted to producers at a staggering rate.  Furthermore, consumers send direct messages to producers as well – chiefly by indicating how much they are willing to pay for a certain good or service, i.e. what is the price the consumer is willing to pay?

Going back to our iPad example, consumers have sent a very clear message to the executives at Apple.  That message is:  we are more than willing to pay between 500 and 800 dollars for the iPad 3.  Not only that, but we consumers are willing to buy all of the iPads you can produce at that price and we consumers will also camp outside of stores and have a party waiting for you to allow us the privilege of buying your product.

Apple receives that message loud and clear.  When they get that type of reaction, Apple knows that they have created the right product and more importantly, affixed the right price.

Now let’s apply a hypothetical to the iPad 3.  Suppose tomorrow Apple decided that rather than charge 500-800 dollars per iPad – they now want to charge 5,000 to 8,000 dollars per iPad.  What would happen to Apple sales?  It is pretty obvious the sales would plummet.  People, other than the spectacularly wealthy, would not pay that kind of money for a tablet.  Consumers would send a clear message back to Apple on the subject of price.  Attention Apple: either you price the iPad lower or we no longer will buy your product. 

In fact, there is no amount of advertising or celebrity endorsements that could get any of you to pay 5,000 bucks for an IPad. 

This is true of almost all industries.  Anyone selling a good or service, must price their product to please consumers.  There is no other way in a market to get customers.  If I am selling chocolate bars and I am pricing them at 7 dollars apiece – I am not going to be making chocolate bars very long.  What Adam Smith called the “invisible hand” is not invisible at all.  Consumers are very open and honest about price and the optimum price is very visible.  It is blindingly obvious to any producer, what the acceptable price should be for any product.

Price is the great and indispensable communicator in the marketplace.

There is only one problem with all of this.  There is an organization that always wants to meddle with prices.  This organization want to fix prices, drive prices up, propagandize against prices, or artificially set prices too low or too high.  This organization wants to stop the open communication between consumer and producer.  This organization is literally jamming the communications between sellers and buyers.

Yes, you guessed it – that organization is your government.

How government help destroys accurate pricing, sends false messages in the marketplace and ultimately exacerbates the problem

Okay folks – let’s go back to the iPad 3 scenario one more time.  When last we left the scene, we had producers jacking up the price of an iPad 3 to 5,000 to 8,000 dollars per unit.  Consumers naturally were indignant.  Five grand for a tablet?  Take a hike Apple!  We are not paying that.

Under normal circumstances, Apple would get the message.  Executives would see that the sales last month were down to about zero and say “I think we need to lower the price.  People hate the price.  We need to lower the price in order to meet the expectations of our consumers.  If we keep the prices this high – no one will buy our products.”

Enter the government.  The political leaders watching this scene know the iPad 3 is a sweet machine, they also know people, aka voters, wish they could afford it.  So government does what it does best:

Government intervenes in a process it doesn’t appreciate, to distort a market it doesn’t understand, in order to get the votes of people it doesn’t really know.

So, in an amazing display of bipartisanship, the congress passes and the president signs a new law providing grants of up to 10,000 dollars to people who can’t afford iPads.  Additionally, since not everyone will be eligible for a grant – the government creates a low interest loan system, where people can get a government backed loan of up to 7,800 dollars to buy an iPad. 

Has government solved a problem?  No.  Will the price of iPads go down?  No.

People will certainly avail themselves of the “grants” and low interest loans to buy iPads.  In fact, there is so much grant money and low interest loan money available that people aren’t bothered by paying 8,000 dollars for an iPad.   Consumers have always been willing to pay 500 – 800 dollars for an iPad, but when consumer contributions combined with loans and grants from government, the new “price” people are willing to pay for an iPad is about 8,500 dollars (7,800 in grants/loans + 700 out of pocket dollars).

The Apple corporate headquarters receives this message.  Consumers, now teamed with government, are willing to pay 8,500 dollars for our product which we could have sold for 800 dollars.  Wow!  What a profit margin Apple is now enjoying thanks to the caring people in government. 

What do you suppose Apple will do with all that profit?  Yes, some will go back into the corporation to find better products to build.  But here is the real insidious part.  Now that Apple has received a clear message in the form of the government subsidized price, Apple is going to do everything possible to make the government grants/loans to buy iPads permanent and larger.  Apple is going to lobby.  Apple is going to donate to campaigns.  Whatever is necessary to keep the price of iPads artificially high with the help of Uncle Sam.

The end result is the government is spending a ridiculous amount of money (tax dollars) to allow Apple to have a ridiculously high price for the iPad.  Additionally, the people are no longer tuned in and are no longer sending their original message about price to Apple.  The people are unhappy about high taxes and high deficits, but they think that is a different subject.  Apple is very happy.  They are selling their product at a hugely inflated price.

Ultimately, in our scenario, Apple doesn’t have to price its product so that people can actually afford it. 

What a disaster.          

Government – the great miscommunicator

Government intervention in pricing is a bad idea.  It creates a destabilizing effect and rather than help consumers, it actually harms consumers.

Don’t believe me?  Take a look at what government has done in the area of college tuition.  The price of college has been rising at a staggering rate for decades!  How is that possible?

When you look at higher education you see that there are an awful lot of schools out there.  There is plenty of competition in the market place.  Competition usually drives prices down.  Additionally, inflation in the United States has been tiny since 1983, yet inflation in college prices during that time is absolutely skyrocketing.     

So why are universities charging so much money to get a bachelor’s degree?  Aside from the very wealthy, no one can afford to buy, with their own money, the product that the universities and colleges are selling.  Does this sound familiar?  It should.  It is exactly what our fictional Apple company did in the scenario above.  Just as the company jacked up the price of tablets so that only the very rich could afford the product; colleges and universities have jacked up their prices.

People cannot afford to pay the tuition.  This is where people would normally stop buying the product.  But instead, government has rushed in with grants and loans.  The consumer becomes numb to the ridiculously high tuition because the “government (taxpayers) are paying.”  The university takes a great deal of the money it earns from grants/loans and lobbies back to the government for more grants, cheaper loans, etc – anything they can do to ensure that the huge tuition payments keep rolling in.  The real message from price in the marketplace is squelched and it has been replaced with a false message from government spending.

Just watch the news this week and listen – the entire focus is on how we get more money transferred from government to consumers, so that the Colleges and Universities will never have to lower their prices.

It is truly insanity.

What kind of a business prices its product so that no one can afford it?  A terrible business, that’s what kind.  If I wanted to charge 50 dollars for a can of soda, or 10,000 dollars for a pair of running shoes, or 26,000 for television, the American consumer would run me out of business in a month.  They wouldn’t buy anything from me.  I would have to be the worst businessman in America to demand those prices.  I’d have no income and I’d be quickly out of business. 

Yet today, America’s colleges and universities intentionally price their product so most consumers cannot afford to pay.  What kind of a business would do such a thing?  Only an industry that is insulated from consumer feedback by virtue of the disastrous intervention of government would do such a thing.

This week, we have political leaders calling on universities to “hold the line on tuition.”  What a strange thing to ask when you are simultaneously using tax dollars to pay whatever tuition the school decides they feel like charging.

Why would any university change that?  They have already priced their product so high that without government grants and loans, most consumers cannot afford to pay.  And despite an over-priced product, the universities enjoy massive incomes and their employees get paid large salaries.  Who would want to change that?

Only consumers would want to change that.  If consumers couldn’t afford to pay tuition – guess what?  They would stop buying the over-priced product.  Tuition would be forced down to an acceptable price that people could afford or schools would go out of business.  Either way, the higher education system would be cheaper and more responsive to their actual customers.

Instead, we have a government subsidized mess.

– CJ Cheetham

*NOTE – Apple seems like one heckuva a great company to me.  They always deliver better, cheaper, faster products to their consumers.  May it always be so!  Apple was only used as a hypothetical example of how government  destroys the critical role of price in the economy.