Myth: Low Prices are Good for the Economy

Once again, here is another ignorant idea about our economy that your average 4^th grader could recognize as being untrue. To see why I say this, let us assume that you sell pumpkins for $5.00 each and I want to buy one from you. How would you change the price of the pumpkin so that the resulting change would be “good for the economy"?

It should be painfully obvious to you that it is impossible to do so. No matter which direction we move the price, as good as the change is for one of us, that change will always be equally bad for the other. So, if the idea of low prices being “good for the economy” is so obviously not true, how is it that so many people believe so strongly in it? There are several reasons, but we will only focus on two of the main ones.

First of all, the economy is so large and so complicated that it is not clear to the average consumer what the impact is of his/her purchase decisions. So whenever a consumer “saves” some money on their purchase, they cannot see who is actually taking the “loss” on the other end.

Secondly, due to a complete lack of any meaningful economic training in our educational system, the average American is completely unaware that there is a huge difference between looking at the world from a business perspective and looking at the world from an economic perspective.

Looking at the world from a business perspective only requires you to look at the world from a singular perspective; that is, from the perspective of one business, one household, one individual, etc. In each of these cases, income and expenses are separate from each other. So if you are a baker and the price of flour goes up, then that is “bad” for your business because your expenses just went up. On the other hand, if you can raise the price of the bread that you sell, then that is “good” because your income just went up.

In contrast, when you are looking at the world from an economic perspective, you always have to look at things from multiple perspectives. From the standpoint of the economy as a whole, there are always two sides to every price. On one side of the price tag you have income to the seller and on the other side of the price tag you have an expense for the buyer.

So from an economic perspective, if the price of flour goes up, it will be bad for the baker, but good for the flour maker. If the price of bread goes up, it will be good for the baker, but bad for the consumer. So overall it is not clear if a price movement is good or bad for the economy because one side’s gain always appears to be the other side’s loss.

Unfortunately for all of us, due to our weak educational system, most Americans are only capable of looking at the world from their own singular perspective. Therefore, they tend to naively assume that price movements are either good or bad; they tend to assume that a price increase is “bad” (because it appears to be bad from their individual perspective) and that a price decrease is “good” (because it appears to be good from their individual perspective). Not surprisingly, these people have been easily fooled by big companies like Wal-Mart into believing that “low prices are good for the economy”, simply because low prices appear to be “good” for them as an individual consumer.

What everyone needs to understand is that prices are like a thermometer. A thermometer can provide us useful information about a patient, but it will not affect the health of the patient; that is, a thermometer is not going to make you sicker or healthier.

Similarly, prices can provide us useful information about what is going on in the economy, but they do not drive the economy. So lower prices are not “good” for the economy and higher prices are not “good” for the economy. The different price levels simply relay information to us about what forces are at work in the economy.

#EconomistsAreMorons