How Markets Foil Collectivist
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The Economics profession has largely
failed society up to this point because it has failed to expose the
utter folly of Collectivist Schemes promoted by politicians that are
ultimately based on a logical error known as the FALLACY OF COMPOSITION.
The schemes are very popular, politically, because they foolishly
promise to reward 'everybody', even though it is virtually
guaranteed that they will end up rewarding nobody. What is the Fallacy of Composition?
It is an error in logic that observers make whenever they mistakenly
assume that all the members of a group will benefit from a
certain behavior if a single individual clearly appears to
benefit from that behavior. In economics, there are many
times when this assumption is simply false:
During a recession, it is prudent for an individual---who
doesn't know if she will have her job four months from now---to
postpone purchases of durable goods, avoid taking on new debt,
pay off old debt, and save for new purchases. But
unfortunately, if everyone were to do that, the recession
would quickly become much, much worse.
An individual firm, in an effort to expand market share at the
expense of its competitors, might be inspired to cut prices.
But what happens if all of them do the same thing?
Saving money is always a good thing, right? But what if
everyone started saving for all of their purchases and no
one ever again borrowed? One of the celebrated benefits of
saving money---earning interest income---would disappear. It
turns out that savers need borrowers if they want to
benefit optimally from saving money.
Far more often than most people realize,
it is exceptional behavior that is rewarded by the economy.
Let's consider one more hypothetical example:
When individual lottery winners collect
their millions, they enjoy a dramatic increase in their purchasing
power. Suddenly, they are able to make a claim on the scarcest
goods & services that the economy makes available. But what if our
politicians in Washington were to decide one day to simply hand out
a million dollars to every household in America? We’d all be able
to share the same great experience of luxury living then, wouldn't
Economists know that such a plan
would simply cause an explosive round of inflation. Over a fairly
short period of time, the price of everything would skyrocket
dramatically. After the hyperinflation had finally run its course,
there would still be the same number of rich and poor and middle
class citizens in the country as there were before the
million-dollar gift was distributed. Why? Because the amount of
goods & services that would be available in the country the day
after the million dollar giveaway would be essentially the same as
the amount that had been available the day before. Giving
people more money would
not make the scarcest goods & services multiply magically.
The end result? The same quantity of good & services would be
consumed as before, just purchased at dramatically higher prices.
Because some goods & services are absolutely limited in their
there would still be the same number of rich people as before.
What is the Market mechanism that
guarantees that collectivist schemes like this will fail? In a market economy,
suppliers can always be counted on to charge the highest prices that their
markets will bear. That is to say, they will charge as high a
price as they can, so long as they are able to sell everything they
If a shortage develops in some market, sellers will raise their
prices because they know that some people will be willing to pay a
higher price for what little there is. Buyers will pay the
higher prices because (1) they have the money to do so, and (2) they
don't want to do without. Sellers also raise their prices if
they notice that an increase in disposable incomes has occurred.
They want to get as much money as their customers are willing to
pay, period. The only way they can find out what the optimal
price might be is by raising the price until they are no longer able
to sell what they have.
That's how The Market works.
Because there are not enough scarce 'experience opportunities' available for everyone to
know them, the marketplace 'auctions them off' to the highest
'bidders.' It's a different sort of auction from those that
most people are familiar with, but it is still an auction.
Sellers try to guess what the highest successful 'bids' will be and set a
'price' for the goods they are selling. Those who cannot
afford to pay a seller's asking price will 'submit their own bids'
only if the official selling price is lowered to a level that they
can afford. In other words, in this kind of auction, the only
bids that are offered are those that are certain to be accepted by
If a supplier/auctioneer sets her prices higher
than she should, she won't be able to sell all of her product.
She will then have to lower her prices to a level that more
consumers find affordable. If, on the other hand, she doesn't
charge the highest price she can get from the market, she'll
find that she has too many customers clamoring for the limited
amount of things she has to sell. She will then want to raise
her prices until she finds out which higher price imaginable
is still low enough for her to sell all of her product.
Due to the limitations imposed on us by
Nature, our economy is not able to produce enough of the "best
quality" goods & services so that everyone can experience them. In
a market economy, if you want to be one of those who gets to
experience the rarest of economic privileges, you must obtain a
level of disposable income/wealth that is high enough for you to
outbid other potential consumers for them. This is essentially why
it is the distribution of income/wealth that ultimately determines
who gets to experience them and who doesn't.
What is important is not the dollar
wealth you are able to accumulate; it's the dollar wealth you are
able to accumulate compared to everyone else. The
purchasing power of your income is determined solely by its
relative position amongst all accumulations of disposable
income/wealth. Because we have a market economy, an individual
can improve her claim on the scarcest goods & services only if she
can improve her comparative bidding position
within the hierarchy of national money wealth distribution.
Whenever an individual household is able
to increase its disposable income, its purchasing power will either
increase, decrease, or not change at all depending on what has
happened to the disposable incomes of all other households. If
your disposable income remains the same next year but everyone
else's income declines you will actually see the purchasing power of
your stagnant income increase. Suppliers would be
forced to drop their prices and you would discover that you have
acquired a bidding advantage over others. Even if your income
were to drop next year, you would still be better off if everyone else's
income dropped even more.
Perhaps now it is easier to see the
folly of Collectivist Schemes. What kind of schemes are we
talking about? Well, there's the "everybody needs a tax cut"
ploy. What happens if all taxpayers receive an income tax cut
[in a way that preserves all taxpayers' rankings within the
hierarchy of disposable income distribution]? Answer: none
of them experiences any real gain in purchasing power.
We can be certain that prices will rise in the marketplace until all
of the extra 'purchasing power' is nullified (because sellers can
always be counted on to charge whatever prices the markets will
Likewise, it is also true that increasing the income tax
obligations of all citizens in a way that preserves each taxpayer's
ranking within the hierarchy of disposable income distribution
ensures that none of them experiences any real loss in purchasing
power. Prices will drop until all citizens can afford what
they would have been able to afford if they had not had to pay more
Progressive Income Tax is widely misunderstood today because people
do not realize that it collects money from taxpayers in a way that
ensures that each is spared the decline in purchasing power she would otherwise have experienced if
only she had paid the tax.
Another example of
collectivist folly is the legislation passed by Congress that
seeks to help all businesses by reducing their costs.
If all firms benefit from the same kind of
government-sponsored cost reduction (like a tax cut),
then none of them ultimately benefits. A firm can
increase its market share only by obtaining more disposable cash
than its competitors. If all firms experience the same
gain in profits, then prices in asset/resource markets will simply be
bid up until the "gain" that every firm received is wiped out. In business, the
only way it is really possible to get ahead in a competitive
environment is by cutting your costs more than your
government edicts force an increase in costs on all firms,
they are all spared the hurt that each of them would have
experienced if only they had been forced to absorb the cost.
For example, we know that if/when an individual firm gives all of
its employees an extra week of paid vacation, its costs increase in
a way that could put it at a competitive disadvantage. But if
all firms are forced to give all of their employees an extra
week of paid vacation, then none of them is actually hurt by
Either (1) they
will all be able to pass on the extra cost to their customers or (2)
they will all have to accept lower profits. In the latter case none
of them would lose out because all would be experiencing the same
drop in net profits, which means price levels in resource markets
would drop to levels they could afford.
Business owners in a market economy need
to focus on two things if they want to optimize
their "Real Wealth enjoyment": (1) They must optimize society's
overall productive output generally, while (2) seeking also to
minimize their own costs (maximize their own disposable
incomes) vis-à-vis their rich peers/competitors. If they seek
instead to increase the disposable incomes of all rich
people in a way that does not directly help to eliminate
unemployment, then they reveal themselves to be deluded fools who
end up victimizing themselves as well as others through their
It certainly is not
difficult to think of more examples of these kinds of collectivist
political attempts by various groups to obtain 'easy enrichment' for
themselves (their group). It's not just that they are foolish
ideas; they cause a lot of unnecessary suffering to occur.
If, for example, the nation is suffering from unemployment, we can
eliminate the problem painlessly by increasing the income tax
rates of rich people and then using the money to finance government
improvements of the infrastructure. But that solution can
never be exploited if most rich people mistakenly believe that a
higher tax bill would actually deprive them of some purchasing power
(it would not). If we can all become aware of the true folly
of Collectivist Schemes, we will be able to focus our attention on
policy initiatives that can bring about real improvements in
our collective welfare.
Edited, December, 2005
Related Economic Analysis:
UNEMPLOYMENT: OUR GREATEST ENEMY
BETWEEN SAVINGS & INVESTMENT
DO TAX CUTS STIMULATE THE ECONOMY?
ARE INCENTIVES NEEDED TO
MEASURING SAVINGS AND