Modern economics has what is called “Equilibrium Theory” to explain how prices are reached. It is wrong. This is not a minor refutation as this is the foundation of modern economics, and contemporary economists base their careers on this.
For starters let’s understand what “Equilibrium Theory” is. Basically it argues that multiple parties will trade around an optimum and equal price point. Prices above or below this point will cause shortages or inefficiencies. I would argue this point doesn’t exist in reality. At its core, “Equilibrium Theory” is circular and self-defining. If you told a micro-economics professor this, they would likely flunk you from their class…but it is true.
Say we strand Bill and Frank on a tropical island. For starters they don’t trade…they each can produce 1 fish and 1 coconut in a day. But if they specialize, they together can produce 10 fish and 10 coconuts together in a day. A good question then arises…if they both specialize, then what will be their trade ratio (price)? Modern economics will simply divide production equally (5 fish and 5 coconuts for each), but this is wrong. There is no reason why Frank wouldn’t trade say 7 fish for 4 coconuts.
First to understand why, we must appreciate the concept of the “increment of association”. Whether somebody trades or choose self-sufficiency depends on the benefit they get from specializing. So with Bill and Frank they can produce 1 coconut and 1 fish by themselves (2 coconuts and 2 fish total). But together with specialization they can produce 10 coconuts and 10 fish. This means the “increment of association” was 8 fish and 8 coconuts. Let’s say Bill thinks (wrongly) that he does more work to catch his fish so instead of trading 5 fish for 5 coconuts, he demands 7 coconuts for 5 fish. He can actually get away with this, as Frank can’t easily refuse. If Frank doesn’t trade at all, then he’ll only get 1 fish and 1 coconut a day. 5 fish and 3 coconuts is much better!
Would more people on the island help? Yes and no…but still there is no set equal price theory. The concept of whether there are 2 people, 3, 20, or 8 billion…it’s all the same. Humans either trade or engage in self-sufficiency. They trade to access a piece of “increment of association”. But because this output is always larger than the input, it can be unequally distributed without producing shortages.
So in reality what determines an exact price if not supply and demand? Supply and demand do determine an equilibrium price range but not a equilibrium point. To determine the exact price, we need to factor in a missing consideration so obvious and simple that it is shocking it has never made it ways into modern economic price calculations…and that is is bargaining power. More precisely, the ability of a trading participant to reasonably threaten to withdraw from trading to increase a price.
Labor accomplishes this through unions. Capital accomplishes this through corporate mergers. They are shockingly similar. Both seek power by increasing their base. The larger the base, the more scarier their threat to strike is. The scarier their threat of the strike, the more money they will get.
Note this overlaps somewhat with games theory. A good analogy is the game of chicken. Two drivers drive toward each other. The last to swerve aside wins. But if there is a crash, nobody wins. Now imagine there are 10 cars coming at 1 car. That one car will have to swerve much earlier because of this.
Some larger corporations actually don’t even need to merge to enjoy the fruits of monpolistic pricing. They can actually specialize away from their competition (as their competitors do likewise). Union Pacific gets to operate railroads in the western US, CSX in the east, etc… This is depressing as it means businesses are not only actively seeking to increase revenue and decrease cost…but to grow for growth sake. Many mergers are not simply explained by just economies of scale (in fact many introduce huge diseconomies of scale), but rather to grow their bargaining power. That modern economics doesn’t factor this into their equations is a huge failure.
Another great example of this is in our grocery store. Roughly ten companies control the food we eat. While these CEO’s will argue this for economies of scale, it’s mostly to increase bargaining power in a cat-and-mouse game between vendors and suppliers. If you try as a small farmer to supply cereal to Walmart you will be bullied and not get your fair price. But if you sell your cereal company to GM and they sell to Walmart, they will get a better price, regardless of any operating efficiencies from the merger.
The other take-away from bargaining power is price volatility. This means that prices naturally will be violitile and erratic. In fact static prices are likely a sign of a monopolized industry.
What the solution is I don’t know. Socialists will argue for nationalizing industry and communists for mass welfare, but neither is a great solution. Governments are easily corrupted and often any solution they provide will just make the problem worse. Labor unions are an option, but they too can become bureaucratic, political, and evil. In an area with modern immigration and trade, it is also very easy to bypass them.