Cafe Hayek: The Fallacy of Affordability

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October 27, 2005

The Fallacy of Affordability

Russell Roberts

One of the most dangerous myths or fallacies of economics is that prices or wages are determined by what businesses can "afford." In this fallacy, Wal Mart should pay more than they do because, after all, they make a profit. They have money left over. This view fails to understand the role of profit in an uncertain world as a motivator to take risks.

Exxon and Mobil made a lot of money last quarter. The Drudge Report headline on the story:

OK, HOW ABOUT LOWERING THE PRICES NOW?!?

I'd be tempted to answer by saying, well, Drudge, if they lower prices when profits are high, are you willing to make a charitable contribution to oil company stockholders when profits are low or negative? But the real error isn't the asymmetry. It's the assumption that transactions are zero sum--the implict assumption in the headline that when prices are high, I'm exploited so it's time to give me a rebate. There's no understanding of the role of high prices in motivating beneficial behavior on both sides of the market--for consumers to find ways to get by with less gasoline and for oil companies to be motivated to find and bring more oil to the market. Economists of the world, unite! Help the world understand the role of prices.

Posted by Russell Roberts in Myths and Fallacies, Prices | Permalink

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