What is a Fair Price?

The concept of pricing goods and services is a central topic is business and economics. Of particular importance is what constitutes a fair and reasonable price, and when we can confidently label a pricing scheme as unwarranted or exploitative. Is there a way to determine objectively what price something should be?

One way would be to calculate the fair market value of all the material constituents, labour, and overhead used in the creation of a product (direct materials, direct labour, and overhead costs are calculated by accountants, who then use this information to help management to price products in the most optimal way). We would also have to calculate all other costs of doing business, such as interest payments required on bank loans, depreciation on equipment, and corporate taxes. This would give us the minimum price, where our costs would exactly equal revenue.

But we can never truly compute the true cost. This is because the prices of all the components the go into the creation of a product are not in a state of equilibrium. They are always changing as consumers and producers make their preferences known in the market. Supply and demand in the market sets prices – and these prices change continually. While it may be possible to objectively assess the fair price of something in the spot market (such as gold or copper), the price we see is only valid for that particular point in time – it can change from minute to minute.

Of course, the most difficult number to quantify based on purely objective metrics is the markup price. What is a fair markup for a product or service (or wage for that matter)? How much profit should the business owner earn?

Everyone has a different answer. Free market devotees say there should be no limit and to allow the “invisible hand” to work things out. Those skeptical of the capitalist economic system proselytize for price controls to ensure companies don’t take advantage of consumers and workers.

In his book Defending the Undefendible, Walter Block provides an example of the quintessential slumlord and explains why his decision to charge seemingly exorbitant rates for his dilapidated properties is actually perfectly rational and reasonable:

But what of the claim that the slumlord overcharges for his decrepit housing? This is erroneous. Everyone tries to obtain the highest price possible for what he produces, and to pay the lowest price possible for what he buys. Landlords operate this way, as do workers, minority group members, socialists, babysitters, and communal farmers. Even widows and pensioners who save their money for an emergency try to get the highest rates possible for their savings. According to the reasoning which finds slumlords contemptible, all these people must also be condemned. For they “exploit” the people to whom they sell or rent their services and capital in the same way when they try to obtain the highest return possible. But, of course, they are not contemptible – at least not because of their desire to obtain as a high return as possible from their products and services. And neither are slumlords.

People generally wish to purchase products at the lowest price possible. The problem is , of course, that people not only act in their roles as consumers, but as producers as well. While most people are not business owners, they do act as producers by working blue collar and white collar jobs. And when it comes to their compensation they demand the highest wage or salary possible.

As consumers we want low prices, but as producers we expect high wages. We sometimes forget that wages are a cost that is accounted for in the various products we wish to purchase, and fail to realize that as wages increase, so do the prices of products.

Employers routinely would say that workers are charging too high a price for their product (meaning their labour). Are workers and union bosses being unfair and unreasonable when it comes to their compensation demands?

At the end of the day can we at least come up with a precise definition of “fair price.”

A fair price is what the seller is willing to accept and what the buyer is willing to pay. It matters little the psychological reasons for a why a transaction occurs at a particular price (that’s for behavioral economists to ponder); what’s key is that both parties believe they are better off for engaging in the trade.

Some would say that the buyer would not willingly pay a particular price, let’s say, $500 for a computer. They acknowledge that the transaction, if accepted, is of the buyer’s own volition, but go on to say that is was done so begrudgingly (for example, there may have been a shortage of computers and the seller was engaging in price gauging). They say the price the buyer would want to pay is much lower and “fairer.” If he was really able to, he would not pay $500, so how could the transaction be deemed fair?

But what price, then, would be characterized as fair? $450? $400? $375?

In the same chapter of Defending the Undefendible, Walter Block points out the absurdity in the concept “ideal price”, with the slumlord as an example:

An additional reason for calling the claim unwarranted is that there is, at bottom, no really legitimate sense to the concept of overcharging. “Overcharging” can only mean “charging more than the buyer would like to to pay.” But since we would all really like to pay nothing for out dwelling space (or perhaps minus infinity, which would be equivalent to the landlord paying the tenant an infinite amount of money for living in his building), landlords who charge anything at all can be said to be overcharging. Everyone who sells at any price greater than zero can be said to be overcharging, because we would all like to pay nothing (or minus infinity) for what we buy.

The problem with ideals: they don’t exist on this planet. Please visit Plato’s realm of Forms instead.

Notes

Block, W. (2008). Defending the Undefendable. Auburn, AL: Ludwig von Mises Institute.

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