Thursday, April 26, 2012

Supply, Demand and the Illusion of Choice.

George Carlin had some amazing rants about the illusion of choice under which we live in this country.  He used to say that we don't have freedom in America, we have the illusion of freedom and we don't have choices in America, we have the illusion of choice.  His quote was "You know what our choices are in this country?  Regular or decaf.  We don't have real choices."


This quote and Carlin's rant pops into my head whenever I hear someone talk about supply and demand in our current economy.  


Anyone who's taken a high school economics class understands the basic concept of supply and demand.  It's brilliantly simple, for every good or service on the planet there is a finite supply and a potentially infinite demand.  Because there is only so much of a good that can be produced or only so many people able to provide a particular service, the greater the demand is, the lower the available supply becomes.  This results in an increased price.  On the other hand, if demand for a good or service is low, then the supply will be higher than the demand and the price will fall.  The supply/demand curve is illustrated simply in this diagram:




Supply and demand primarily affects price, but it also affects production.  If demand for a product is high, then manufacturers increase production to keep up with demand.  Conversely, if demand for a product is low, manufacturers will decrease production.  The equilibrium point for production in the supply and demand curve is the point where the two intersect - as is indicated by the dotted lines in the above diagram.  This is the point where there is the most demand for the product at the highest possible price that will result in the greatest overall profit.  This is the sweet spot that all producers seek - if the price is lower, demand will increase, but profits will decline.  If the price is higher, demand will decrease and profits will also decline.  At the equilibrium point, your profit will always be the highest possible, or so is the case in a pure competition based market.


The strength of the basic supply/demand model is that the consumer drives all the essential aspects of the market.  They keep prices reasonable, they keep quality high and they keep supplies adequate to meet demand.  In a pure competition market, poorly made products would have a low demand and the producers of that product would either have to lower prices to increase demand or increase the quality of that product.


It's this simple concept of a consumer-driven quality control mechanism that has deceived people into believing that the current market we are living with today has anything at all in common with the autonomous controls in a free, pure competition market that we learned about in school.


See, we have been taught that, in a capitalist, competition-driven market, the consumer will always have the most choices, the highest quality and the best prices.  The flaw in this system occurs when there is not enough competition in the market, for one reason or another, to create a true competitive choice.


In our current economy, basically every major industry is dominated by a handful of mega-corporations.  90% of the banking, oil, energy, food production, healthcare, automotive, transportation and communication industries are controlled by 5 or 6 corporations.  Many of these corporations are so large and diversified that they own interests at multiple points down their supply chain and in many different industries.


This changes the supply/demand model drastically.


When 90% of the food you buy in your local grocery store is produced by one of 5 companies, your choices are limited and prices tend to be less flexible to demand.  It doesn't matter if the people want a significantly higher average quality or lower price, because the power of choice becomes less and less of a factor the fewer actual choices you have.


In basic economics, we learned that this state of the market is found in a monopolistic economy and, from a political standpoint, these types of economies typically exist in socialist, totalitarian or communist regimes.  In a monopolistic economy, one company controls all the production in a particular industry.  Due to having a 100% control of the market, this company will set prices and supply at their whim and their equilibrium point would exist much higher than in a pure competition market, since when you only have 1 choice, you pay whatever price that item is selling for or you don't buy it.  Of course, the long-term effect of a monopoly is that quality will steadily decline and so will demand, which will result in decreasing revenues until the company can no longer continue to operate, or so we're told.


In America, we have a system currently that is very close to a monopoly.  Instead of 1 company controlling an industry, we have about half a dozen.  This gives the illusion of choice, because people see more than one business in an industry and assume those companies will be competing against each other to give customers the highest possible quality at the lowest possible price.  We've been taught about anti-collusion laws and other regulations that protect consumers from price fixing by suppliers.  We learned about anti-trust laws and the efforts of the government to break up monopolistic trusts such as Standard Oil, Bell Telephone and recently Microsoft.  


However, in the last 3 decades, there has been an ongoing and consistent effort on the part of these large corporations to influence lawmakers to loosen and lift regulations.  The argument is that the less restrictions you impose on the market, the stronger and more healthy it will be.  If government steps out of the way and lets the market do whatever it wants, then it will always do what's best for the consumer.


This is simply not true, and history has proven it.


Using the food industry again as an example, when government stepped out of the way and allowed mergers that would have been blocked 30-40 years ago, we went from having several dozen different competing companies in the food industry to about 6.  This has resulted in less brand choice and price increases that outpace inflation.  Additionally, because there are fewer companies controlling a significantly larger share of the industry, these companies are vastly wealthier, more powerful and more influential.  Food producers are able to spend billions of dollars lobbying our elected officials to loosen or eliminate regulations affecting the quality and safety of their products in order to maximize their profits.  Consumers are not able to use the basic power of the supply/demand model because our choices have been concentrated and homogenized so that we really have no choice at all.


Take the recent "pink slime" issue.  There was a strong public reaction when people began to learn about ammonia-treated ground meat being added to things like hamburger patties.  This "pink slime" is meant to kill e-coli bacteria and act as a filler in beef products.  The rise of e-coli presence in the meat industry is, itself, a product of the efforts of the beef industry to loosen regulations on sanitary conditions as well as the diet of beef cattle.  The overwhelming reaction of the general public to pink slime was negative - people didn't want pink slime in their hamburger meat.  However, pink slime is still being used, nothing has significantly changed.  But, how could this be?  According to supply and demand, the public dislike for pink slime should result in meat producers discontinuing its use entirely.  Additionally, increased public demand for pink slime-free meat should lead to the rise of new meat production companies that would offer slime-free meat and rake in huge profits by appealing to this growing public demand.  This obviously isn't the case.


So, why not?  Well, for one thing, 90% of the beef industry is controlled by about 5 major companies - all of whom use pink slime.  These companies make huge profits because they are able to keep production costs low by using pink slime.  To discontinue using pink slime would increase their production costs and lower their profits, so they continue using it.  So, why can't we the consumers simply stop buying meat from these producers and buy it from companies that don't use pink slime instead?  Well, because the handful of companies that control the meat industry have erected huge, prohibitive barriers to entry that make it almost impossible for a small, independent producer to effectively compete with the big industry leaders.


Put another way, McDonalds, Burger King, Jack in the Box and every other major fast food company uses beef that contains pink slime.  They use it because it's the cheapest beef available and thus will result in the highest profit potential.  Further, these businesses have contracts to buy their beef from one of the handful of beef producers that dominate the industry and are offered a price per unit that is so low that it's only profitable when production numbers are incredibly high.  There is no way an independent beef processing company could make enough pre-processed beef patties to compete with the scope of a company like Cargill or Tyson, they don't have the resources and never will because they're stuck in a catch-22 situation.  They can't grow large enough to compete with the major corporations because they can't produce as much beef as they can and sell it for as low of a price.  They can't produce this beef for this price because they aren't large enough to accommodate that level of production.  Basically, you can't get big enough to compete unless you sell at their level, but you can't sell at their level unless you're big enough to compete.  This reality of the industry is why you will regularly see small, independent food companies that emerge on the scene, gain some national sales success and then are promptly bought out and absorbed by one of these industry-leaders, where they fall in line with their parent corporation's objectives.  


40 years ago, this would have been considered monopolistic trust creation and these large food production companies would have been broken up into smaller, more competitive entities.  Today, these same companies are allowed to simply absorb their upstart competitors, which not only allows them to continue to grow larger and more powerful, but also ensures that any real competition for our consumer dollars is eliminated and we continue to live with the illusion of choice.


So, you can either buy your pink slime burger from this brand or you can buy it from that one, but you're buying a pink slime burger.


Supply and demand work only in a market where there is real competition and a vast and diverse pool of producers willing to accommodate a vast and diverse pool of consumers.  When you have 5 or 6 companies offering 5 or 6 different versions of essentially the same product at essentially the same price, there is no real competition, there is no real choice and instead of consumer demand driving production, production drives consumer demand.


Gas prices are another example of the illusion of choice vs. the reality of a production-driven demand curve.


You notice how gas prices all rise at about the same rate, regardless of the company?  Yet, the oil that these gas companies use to make their fuel comes from a variety of different sources.  Yes, this oil is all sold on a global market, so the individual price fluctuations from one producer to the next basically evens out into a roughly flat sell price.  However, surely a company that was looking to expand its market share would find a lower price/quality equilibrium point that would allow them to still make a profit while undercutting their competition significantly enough to win enough public demand to best their competitors.  Yet, this never happens.  You never see an oil company holding a 50% off sale, you don't see a significant difference in fuel quality from one brand to the next.  Instead, what we get is different fancy terms from different companies for additives in their respective fuels that supposedly will result in increased mileage and better performance.  However, EPA fuel economy figures don't fluctuate to reflect the different performance numbers from the different gasoline brands and this is because there is no significant difference.  Filling your car up with 87 octane fuel from Shell will result in the same basic milage and performance as filling up with 87 octane from Texaco or Valero.  30 miles per gallon is 30 miles per gallon, regardless of where those gallons come from.  Thus, all the fancy "techrons" and "techrolines" that these companies use to give you the illusion that buying your gas from them will be the best choice for your dollar is just that, an illusion of choice.  In spite of all these different proprietary additives that are alleged to improve performance, gas prices are identical within a few cents from one company to the next.  In fact, it's not brand competition that drives fuel costs, it's location - gas prices in the more affluent parts of town are higher than in the poorer areas.  There aren't more people driving more cars more often in the poorer neighborhoods, they just have less money to spend on fuel, so, in order to make sure that these consumers don't do something crazy like start riding a bike or taking the bus to work, gas companies will lower prices by about 10 cents or so in order to, once again, give an illusion of consumer control.


Why do prices always skyrocket during the busiest travel days?  Because they can.  What are you going to do, fill your car up with orange juice?  Oil companies have known that Memorial Day is the busiest travel weekend of the year for decades.  If they were bound by a supply/demand market, there would be a competition to offer the lowest prices possible on that weekend in order to earn the largest share of that substantial demand spike.  However, the opposite is the case, each company hikes up gas prices so they can maximize profits.  Consumer demand is irrelevant because every gas company is doing it.  You can't get pissed off at Shell for raising their prices 15 cents right before the weekend and go to Texaco because they raised their prices by 16 cents.  You can't go to Valero because they raised their prices 14 cents.  The difference in price is negligible and never favors the consumer at any point.  This is the pricing behavior we were always taught existed in a monopoly only, unlike the monopoly model, these companies are enjoying record-breaking profits.  Why?  Because, unlike in a monopoly where consumers realize they have no choice and just decide to do without, consumers in a collusion market live under the illusion that there is a difference between Shell gas and Chevron gas.  They see a 5 cent price difference and think that's a product of competition driving prices down, rather than the result of market research to determine how much of a bone the consumer needs thrown to them in order to keep accepting the status quo.


This is the result of our current, conglomerate-driven economy.  Producers choose the options that you will be given and you get to decide which option you like best - or dislike the least, as is more commonly the case.


This same mentality has polluted our politics, thanks to the two-party system.  The general unpopularity of Mitt Romney among conservatives is a product of him not being the best-liked option, but rather the least-disliked one.  Romney isn't the candidate that most conservatives wanted, but he was the least objectionable choice from the limited field they were given to choose from.  Any more, our elections aren't about the best man winning, they're about accepting the candidate viewed as the lesser of two evils.  People are no longer electing leaders based on who they think will do the most good for America, we're picking them based on who we think will do the least harm.


You can go to McDonalds for your pink slime burger or Burger King, but either way, you're gonna eat that slime.

4 comments:

  1. Except the great thing about a free(ish) market is that other competitors do come into the market. I am not going to eat that slime; I can buy my own free-range organic corn fed beef and make a burger at home. I can eat at Five Guys. And if they go out of business, someone else will rise up and give me more choices.

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  2. this is terrible... i know more and i am in nursery

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  3. this is all sh*t...it says so on your profile!

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