Goldilocks Economics

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By Don Newman

The American public has become almost schizophrenic in its viewpoint of the consumer marketplace. On the one hand, if a company becomes too big by offering lower prices for its products it is castigated for unfair competition and putting maw-and-pop stores out of business. Of course, the company referred to here is Wal-Mart.

On the other hand if prices are too high for something, such as prescription drugs or gasoline, then those companies are castigated as well. What prompted this column is a late afternoon story in The Honolulu Advertiser today, April 27, 2006, that the state Attorney General is filing suit against the pharmaceutical companies for “grossly excessive prices” related to the Medicare and Medicaid programs.

It is also true in the case of “big oil” companies that many believe they are “gouging” the public. In both cases the main objection to high prices is that these commodities are “necessities” that people simply cannot do without. Many of those whose lives depend upon certain drugs are on fixed incomes and claim that such drugs are a “necessity” and it is a matter of choice between food or drugs.

The same argument is also used by those who object to high gasoline prices. They must get to work, they must take their children to school and they must go to Wal-Mart to buy their “necessities.” In this case the “necessities” are food and the other accoutrements that truly are the necessities of life.

This kind of dance seems kind of crazy when looked at carefully. Pharmaceutical companies spend billions of dollars discovering, researching, developing and bringing to market life-saving drugs but they are then expected to practically give them away on the logic that they are “necessities” for the people who need them.

Oil companies are expected to comply with a veritable maze of regulations that hamper their every move, yet provide gasoline at a “fair” price. What that “fair” price is, is whatever doesn’t offend the buying public. But how can anyone know ahead of time what this price is? It is when people stop buying. Then companies get the message.

That is the magic of pricing, it is nearly instant communication.

Suppose for a moment you sell a product for $10. It costs you $9 in total costs to produce it. Your profit is $1 and your profit margin is 10 percent. Now suppose your costs double from $9 to $18, so you double your price, to $20. You now have doubled your profits from $1 to $2 but your profit margin is still the same 10 percent. Are you price gouging or merely keeping pace with your cost increases?

The extra billions of dollars that “big oil” is now making is the basis for the capital that will be needed to expand oil field production and refinery capacity, which will eventually bring prices back down, if we can get Al Gore and the other environmental fanatics to permit these facilities to be built. The current high price of gas is a government manufactured problem, and that fact cannot be stated enough.

It is noteworthy that Sen. Ted Kennedy came out in opposition today to the planned wind farm in Nantucket Sound. Need one say more? Not In My Back Yard. Isn’t that what everyone says? What is the alternative? More imported foreign oil, which must be acceptable in this case as long as there aren’t windmills within the Senator’s view.

So there is a real split between what the American public wants and what they are willing to accept. If they truly buy into “global warming” then high gasoline prices are a good thing, since it reduces usage and greenhouse gases. If lower gasoline prices are a good thing, then they have to forego complaining about “greenhouse gases.” It is strictly, either/or -- your personal comfort or global responsibility. You pays your money and you takes your choice.

Some companies are considered “bad” because their prices are too low. Other companies are considered “bad” because their prices are too high. The American people have all become like Goldilocks. Prices cannot be too low, prices cannot be too high, prices must be “just right.” Call it Goldilocks economics.