MARKET AND AREAS OF NO-CHOICE

Examining the applicability of 'market' to services in areas of no-choice.

By Desaraju Subrahmanyam.

See the post 'Business, Government and Services' for an introduction to the terms 'state', 'area of choice', 'area of no-choice'.


ABSTRACT

We argue that for products and services in areas that are inherently areas of no-choice, the concept of the market does not apply. In particular, the notion of 'price' does not apply. Thereby we move towards understanding WHY areas of no-choice are best left to government, and areas of choice are best left to business.


COMMUNISM, BUSINESS AND CUSTOMERS -

Imagine holding a gun to a businessman's head, and telling him to provide a service. Imagine telling him what to provide, when to provide, how much to provide and how much to charge - or else. Would he be able to properly provide the service?

Of course not, and we know what kind of economic system that is: communism. A command economy is essentially no different from putting a gun to the head of a businessman. The condition that the businessman has choice in making investment decisions and other business decisions

such as pricing is vital to the proper production of the service. When choice is removed from the businessman, it distorts the production of the service and makes it a travesty.

The condition of businessmen having choice defines the free market, and the free market is the most efficient system known to provide a stream of products and services to consumers.

Now imagine the gun on the opposite side. Imagine a consumer having a gun put to his head and being told to buy something. Imagine him being told what to buy, when to buy, how much to buy and how much to pay - or else. What would be the repercussions of that?

In the ideological war of the twentieth century between capitalism and communism, the principles of free enterprise and customer choice were vigorously championed in academic and public debate, and became part of the social consciousness in advanced countries. Communism was an assault on businessmen and their freedom, and on customers and their choice. (There is a story about a communist who tells a crowd, "After the revolution, we shall all have strawberries and cream." A man in the crowd says, "But I don't like strawberries and cream." The communist replies, "After the revolution, you will have strawberries and cream, AND like it.")

But customer choice has a flip side - namely, customer no-choice: there are products and services that people have no choice but to obtain.

In such areas of no-choice, the 'customer' is exactly in the position of having a gun put to his head. Of course, the gun is not there because of ideology, it is there owing to a complex of factors including sheer chance, and though human volition and action can be one of the factors (particularly with victims of crime), that human action is not intended to force the victim to seek a service. YET THE EFFECT IS THE SAME: no choice. For such products and services, the concept of 'market' does not apply. The condition that customers have choice in making purchase decisions and other economic decisions is vital to having a market system. When choice is not available to the customer, it undermines the market and all but makes it vanish.

But this appears not to have been clearly recognized - or at any rate has not been forcefully articulated - in public debate. In all discourse, the notion of 'market', with its underlying principles of choice, price and competition are applied willy-nilly to all products and services, without regard to distinctions of choice and no-choice between them.


CONSUMERS AND CUSTOMERS

At this point, we make an important distinction between 'consumers' and 'customers'.

A consumer is a person who USES a product or a service. A customer is a person who CHOOSES a product or service.

Products and services have consumers, and businesses have customers. (By 'business' we mean a for-profit commercial enterprise.)

Not all products and services in society are consumed by choice or provided by businesses, therefore not all consumers are customers.

A customer, however, is always a consumer.

Thereby we DEFINE customers on the basis of the choice they can make, and this definition formalizes the fact that choice is as vital to customers as it is to businessmen; without it, there is no more a customer than there is a businessman.



CUSTOMER CHOICE

The question can be asked: what is the meaning of 'customer choice' when the customer has limited means at his or her disposal to purchase?

How can we say that a customer is 'choosing' something when his or her purchases are dictated by the means at his or her disposal? When a person buys a small car but really wants a big car and cannot afford it, is that 'customer choice'?

The answer is that though the members of an economy are of limited means, every member plans for and chooses what to buy, and when to buy it, from among many different options. The ideal member would purchase everything that gives him or her gain of state, all the time. Real members, however, have to trade-off what to buy and what to forego, how much to buy and how much to forego, when to buy and when to forego, how often to buy and how often to forego. The economy offers the member a range of products and services from which he or she decides on a few, and plans on buying (the higher the level of the economy, the greater the range). It certainly is not 'customer choice' when a person buys a small car while he or she really wants a big car and cannot afford it. But every person chooses from among the many possible ways in which he or she can spend his or her limited means. 'Customer choice' is WHAT THE CUSTOMER CHOOSES TO DO WITH HIS OR HER LIMITED MEANS (including just saving his or her means instead of buying anything.)

That is 'customer choice' in the broadest sense. There are narrower and narrower senses. When a member buys a car, he or she chooses having private transport over using public transport and saving the money (possibly to buy something else). Narrower yet, he or she chooses a car over a bicycle or a moped. And narrower yet, he or she chooses a certain make and model of car over other makes and models. All these are 'customer choices'.

Correspondingly, businesses compete to sell to members with limited means; they compete over which product or service the consumer will choose to spend his limited means on. In the broadest sense, every business is in competition with every other business to attract customer choice. It is only in the narrowest sense that a carmaker competes with another car maker for customers.


PRICES

We now make the argument why, for products and services in areas of no-choice, the concept of 'market' does not apply.

The market system is premised on the existence of certain conditions described in economic theory, using the concepts of marginal utility, diminishing returns, supply and demand, price and allocation of resources based on prices. These conditions obtain only when customers have CHOICE in making purchase decisions: what to buy, when to buy, how much to buy and how often to buy - or not buy at all! When customers do not have choice in making purchase decisions, the conditions for a market do not obtain.

Let us focus on the cornerstone of the market - prices. The market consists of businessmen and customers, and prices have meaning for both of them.

To the customer, prices indicate how much gain of state is possible for him or her, at any given time and place.

To use the terms defined in this blog, price is a measure of gain of state; in general, a higher price indicates that a higher gain of state (value addition) is attained by the consumer. If a product offers higher gain of state, consumers choose to pay higher prices to buy it. If a product is priced higher than the gain of state it provides, the consumer will generally not buy it, and he or she is able to not buy it because he or she has a choice in the matter. Therefore, in general, products and services are not priced higher than the gain of state they provide. For their part, businessmen charge higher prices to provide higher gain of state; in general, they do not charge prices lower than the gain of state provided, and they can do this because they have choice in the matter. Therefore, in general, products and services are not priced lower than the gain of state they provide, and it is possible to attain an equilibrium price.

But paying a price is loss of state, because it is loss of opportunity to gain any other state; to quote from an economics primer, "Consumers will be willing to buy a given quantity of a good, at a given price, if the marginal utility of additional consumption is equal to the opportunity cost determined by the price, that is, the marginal utility of alternative consumption choices." In this blog, we talk in terms of gain of state rather than marginal utility; therefore "Consumers will be willing to buy a given quantity of a product, at a given price, if the gain of state of consuming it is at least equal to the opportunity cost determined by the price, that is, the gain of state of alternative consumption choices."

So a consumer comes to buy when the difference of gain of state brought by the product and loss of state brought by the opportunity cost is positive - the greater the difference, the more likely the consumer is to come to buy (or, more consumers are likely to come to buy).

Therefore when gain of state is high, demand is high; and when price is low, demand is high. When gain of state is low, demand is low; and when price is high, demand is low. (Thus we can assert that if a service is priced higher than the gain of state it provides, the consumer will generally not buy it; the consumer 'knows' what price a service is 'worth' because he or she calculates the opportunity cost based on the prices of the other things he or she can buy with the money. These other things need not even be in the same sector of state; the consumer can weigh whether to buy a new dress or a new cell phone with the money he or she has. Thus all sectors of the economy are bound together in their prices, although the binding is neither rigid nor uniform.)

Further, when gain of state is high and price is high, the differential of gain of state and opportunity cost is low, thereby demand is low.

On the business side, the business incurs costs in making products available on the market. A businessman comes to sell when the difference of the sale price and the production cost is positive - the greater the difference, the more likely is the businessman to come to sell (or,
the more businessmen are likely to come to sell).

Therefore when price is high, supply is high; and when production cost is low, supply is high. When price is low, supply is low; and when production cost is high, supply is low. (Businessmen are attracted to areas of high demand by the high prices, and thereby a supply is soon established to meet the demand. From the social point of view, prices 'tell' businessmen what service is required, at any given time and place.)

Further, when price is high and production cost is high, the differential of price and production cost is low, thereby supply is low.

We have to note that both businessmen and customers are at bottom playing for maximizing gain of state. As money held represents opportunity to gain state, businessmen look to maximize money profit while producing and selling products and services; customers look to minimize money outgo while buying and consuming products and services.

Thus price is meaningful in areas of choice, and markets can exist. Indeed, prices make markets possible.


PRICES CONTINUED

But what is the meaning of price when the 'customer' has no choice in buying or not buying a product or service (or how much and how frequently to buy)?

The answer is: no meaning.

Why? Simply because, when you have no choice, you will pay any price! (In graduated terms, the less the choice you have, the higher the price you will pay.)

The meaninglessness of price in situations of duress hardly needs explication, but here is a simple scenario nevertheless. Imagine that a hurricane devastates an area. Applying conventional theory, the 'demand' for emergency services goes up, and hence the 'price' goes up.

For-profit businessmen who provide emergency services can charge high prices of rescue to people stranded in storm water, and get many orders. If that happens there will be many who cannot afford the high price of rescue, and will remain stranded. The point here is not that some will be left stranded; this is economics, and they are simply outside the demand-band (if you do not have the money to back up your requirement for products and services, your requirement does not constitute demand). The point is that the businessman can offer to rescue people for whatever price they can pay (as long as it is above his costs). It makes more business sense to do this than to ignore those who cannot meet the high price in full. And he can do this because there is no real value addition to the service; it brings no gain of state to which to effectively tag a price. This can be played at the other end as well - just as he pushes down prices for those who have less money, the
businessman can push up prices for those who have more money.

This kind of arbitrary pricing does not work when the consumer has a choice. A rational consumer is alert to the opportunity cost given by the prices of other consumption choices, and will not pay any price higher than what the service is worth. Further, a rational consumer will generally not pay an opportunistic higher price for a product or service that others get at a lower price. If the businessman insists on a higher price, the consumer will simply not purchase, and he or she can very well not purchase because he or she has a choice in the matter. This is one of the reasons why businessmen do not give away products and services for any price that is above their costs, although this would appear to guarantee profits AND attract more customers. Different customers will not and do not pay different prices for the same product or service. That is not 'price', and it brings us back to the fact that prices have meaning - they cannot be anything, anywhere, anytime. (This is not to suggest that prices are always absolutely uniform all the time and for everybody. To the contrary, price is continuously varied by businesses for many reasons. There are price cuts, special offers, holiday discounts; loyal customers, club members and war veterans get lower prices. But such variations are made according to some principle, and are far from arbitrary, "show-me-the-customer-and-I-will-show-the-price" pricing.)

In a situation of disaster or duress, such as hurricane devastation, a person will pay a higher 'price' for rescue even when others are paying lower 'prices' because he or she has no choice. Besides, the person cannot estimate the 'worth' of the service from the opportunity cost, because in a life-and-death situation there ARE no other consumption choices the consumer can consider spending his money on.

(Economists call this 'perfectly price-inelastic demand', and the demand curve is a straight line parallel to the price axis. What it depicts, at bottom, is a condition in which price has become irrelevant. In such a condition markets cannot exist.)

Therefore price is meaningless when the consumer has no choice. As price is meaningless in areas of no-choice, there cannot exist a market for products and services in areas of no-choice. And competition in areas of no-choice will not drive down 'prices'. Businessmen will cartelize rather than compete. (On the other hand, the surest way of breaking cartels and bringing in competition is genuine consumer
choice.)

In short, markets exist only when both the businessman and the customer are free to produce and purchase. (Or, at a simpler level, markets exist only when both the businessman and the customer are free to enter and leave.)

And this holds in almost all areas of no-choice: national defense, police, judicial system, public health, environment, money system - and individual healthcare!


MARGINAL UTILITY, LAW OF DEMAND AND OPPORTUNITY COST

Price condenses and captures all the phenomena of the market, such as marginal utility, law of demand and opportunity cost. A discussion of price is necessarily a discussion of all these market phenomena. If price is irrelevant when consumers have no choice, it means marginal
utility, law of demand and opportunity cost are irrelevant (or do not hold) when consumers have no choice. However, understanding marginal utility, law of demand and opportunity cost on their own terms reveals explicitly their inapplicability to areas of no-choice.

In economics, 'marginal utility' is the fundamental concept. This is the term for the desirability (or 'satisfaction' or 'benefit') of consuming an additional quantity of a product or service, say one more candy bar or one more vacation cruise. The greater the desirability of consuming one more of it (or consuming it once more), the higher is the marginal utility of a product or service. Some products and services have high marginal utility, and some products and services have low marginal utility.

In general, the marginal utility of products and services diminishes: with every additional consumption, the desirability of consuming yet some more of the same product or service decreases. This is the law of diminishing marginal utility. The graphical plot of the marginal
utility of a product or service against quantity consumed is a curve sloping downward as quantity consumed increases. Just as different products and services have different marginal utilities, they have different marginal utility curves: the curves have different starting points and different slopes dictated by the peculiarities of the product or service.

For products and services that prevent loss of state or restore lost state, however, the concept of marginal utility does not apply. When we consider services such as courts of law, police, national defense, firefighting and healthcare, we find that it is meaningless to identify the marginal utility. Such services are not 'desirable' in the same sense that a candy bar or a vacation cruise is - we do not get
the same kind of 'satisfaction' or 'benefit' by consuming them, though we 'need' them in their own way. Indeed, our greatest 'satisfaction' or 'benefit' lies in not having to use these services at all. Therefore it makes no sense to consider the 'desirability' of consuming an additional quantity of such services.

And the law of diminishing marginal utility all the more does not apply. Consider whether a person's 'need' for firefighting services, for example, diminishes after a round of consumption. In general, our 'need' for services in areas of no-choice is constant.

The law of demand is an important principle of economics which states that, for a given product or service, the higher the price, the less it is demanded. The amount of a service that buyers purchase at a higher price is less because as the price of the service goes up, so does
the opportunity cost of buying it. People avoid buying a service that forces them to forgo the consumption of other things. (The law of demand holds for a product or service only when all other factors remain unchanged - for example, the prices of other products and services must remain unchanged.)

The opposing relationship of price and quantity demanded means equally that the lower the price, the more the service is demanded.

Clearly, the law of demand does not apply in areas of no-choice. It is obvious that the demand for healthcare, for example, will not go down if prices go up. As healthcare is a requirement that crushes all others in its path, people will divert money to it by cutting down on all other purchases, and this makes the demand curve look less like the familiar negative-sloping curve and more like the special case straight line parallel to the price axis. Of course, this is possible only within certain limits, as for every rise in price there will be people who no longer have the money to afford it, and that means a decrease in demand by the very definition of 'demand'. However, the limits are broad enough to be significant.

But it is really in the other version of the law of demand that its inapplicability to areas of no-choice is strikingly apparent. According to the law of demand, the lower the price, the more the service is demanded. But the demand for healthcare will not go up if prices go down. People will not cut down on other purchases and prefer to visit doctors and take medicines just because the prices are lower (which
brings us back to the central fact that there is no 'utility' in such services as found in candy bars and vacation cruises).

We can also see, in the above, that the notion of opportunity cost is irrelevant for products and services that prevent loss of state or restore lost state. Where healthcare is concerned, we would not consider having less of it to buy more of something else, or postpone it to
buy something else now; we would go to the doctor as many times as it takes, get as many medicines as it takes, and undergo as many tests and procedures as it takes. Neither would we consider having more of it by buying less of something else: we would go to the doctor ONLY as many times as it takes, get ONLY as many medicines as it takes, and undergo ONLY as many tests and procedures as it takes.

The all-important condition for a market to exist is equilibrium between the businessman and the customer. The businessman always wants to sell at the highest price and produce at the lowest cost; the customer always wants to get the highest gain of state and buy at the lowest price. For any given product, there can be a price at which the impulses of the two are in equilibrium - AS LONG AS BOTH THE BUSINESSMAN AND THE CUSTOMER HAVE CHOICE OVER PRICING AND PURCHASE DECISIONS. When the customer has no choice in buying (or when the businessman has no choice in pricing), there is no price at which the impulses of the two come to equilibrium.

When consumers have no choice over purchase decisions, economists draw a vertical line for the demand graph and call it perfectly price-inelastic demand. When businessmen have no choice over price decisions, economists draw a horizontal line for the supply graph and call it perfectly price-elastic demand. This does not mean that they represent conventional market phenomena just as well as normal demand that exhibits the demand curve. They do not have the same legitimacy - they represent the boundary conditions where normal market phenomena have just about vanished.

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