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Saturday, September 23, 2006

The correct price

Reuters reports that a court in Finland has determined that "[a] fee of 25,500 euros ($32,000) is way too much for a woman to charge a man for fondling her bosom."

Apparently, a couple charged "a 74-year-old who suffers from dementia a total of 25,500 euros to enjoy the woman's breasts on 10 occasions."

Now, if they're schmucking a gent who is not competent to make his own decisions, that's a different matter. But I'm intrigued by the judge's ruling:
Based on general life experience alone, it is indisputably clear that a 25,500 euro charge is disproportionate to the compensation in question.
I am tempted to ask here what would have been a proportionate charge? 5000 euros? 2000 euros? 80 euros? 2 fricking euros?

My point is that there is no such thing as a fixed "correct price" for anything. The right price for any object is determined by supply and demand, and by what the buyer and the seller agree on. The lady in question has a right to demand whatever price she wants for the fondling of her breasts, and the fondler in question has a right to reject or accept that price. If he wants to fondle only those breasts, or if no other owner of breasts is willing to put them at his disposal, then those breasts, and the consent of their owner, acquire a scarcity value. It would then be surprising if the price set wasn't high.

People make a similar mistake when they complain about the prices of commodities shooting up after a natural crisis. (I myself have been guilty of this mistake in the past.) But natural market prices are the best possible way to efficiently allocate resources at any time.

Consider, for example, what happens when an earthquake runs through a village and flattens most of it. Just one store with foodgrains in it is still standing. The prices immediately shoot up there. "Greed," we all scream. "The shopkeeper's making a profit out of other people's misery." We might even support a government regulation that fixes the prices of all his foodgrains.

What happens if such a regulation is indeed passed? Why, the first few people who come there buy up much more than they immediately need, to hoard up in case the crisis continues. And most of the people who come after that find no foodgrains at all. This is inevitable: price controls invariably cause shortages. Had the prices been allowed to rise naturally to reflect demand, though, the first few customers would have bought more prudently, and later customers wouldn't have gone hungry.

In a similar way, to take a Mumbai example from last year, hotels are bound to raise their prices if the city gets flooded and people in the vicinity are stranded and have nowhere else to go. Is this greed? That's irrelevant. Consider what the raised prices do: two friends who would have taken a double room for the night for Rs 3000 suddenly find that the room is now Rs 10,000. So they get together with two other chappies, and the four of them take the room. So, instead of two people inside and two people outside in the rain or the lobby, you have four people in the room. Efficient allocation of resources? Yes. Profit for the hotellier? Yes, and so what? Without the profit motive, the hotel wouldn't be there in the first place.

Another classic example is the price controls imposed on gasoline in the US in the 1970s, which led to shortages that finally disappeared when Ronald Reagan lifted the controls. To read about that, in an excellent short piece in price controls, do read Thomas Sowell's "An Ancient Fallacy: Price Controls." (Also read "Price controls" by Sowell, "Four Thousand Years of Price Control" by Thomas Dilorenzo, "What price controls really mean" by Lawrence Reed, and "Price Control Fallacy" by Don Boudreaux. And I'd also recommend Sowell's excellent primer, "Basic Economics," for more on the subject.

Cross-posted on The Indian Economy Blog.
amit varma, 12:01 PM| write to me | permalink | homepage

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