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The price is right
Rebutting slacktivists with basic competition theory
About one year ago, I was wasting some time scrolling Instagram. I came across a post someone shared about the racism in grocery prices. The post pointed out that minorities in the inner cities paid more for products than for suburban whites. This is a fact that has been studied before as it exacerbates standard of living disparities across racial lines in negative ways. However, the post claimed that prices are higher in poor parts the inner cities due to capitalist greed and capitalists using their oppressive power to profit off racism.
This is obviously a bad argument. But while many people wouldn’t take such a histrionic accusation as valid, many on the left are still inclined to subscribe to notions that capitalists can just raise prices to increase their profits. This debate is relevant today, with many on the left suspecting that corporations are using the guise of inflation to raise prices drastically. While I don’t have time to respond to all the critiques of capitalism in the realm of pricing power, I want to show how viewing the economy as a competitive market and not as a black box of supply and demand can help readers see the problem with activist posts like the one I saw.
In basic microeconomics, the theory of the firm is one of the basic units of study. The concept of “perfect competition” is introduced as one of four generic models for a firm (with monopolistic competition, oligopoly, and monopoly being the other three.) In perfect competition, producers sell fungible products (corn farming is commonly used). In the perfect competition model there are a few implications. The first is that all producers charge the same price. This is intuitive, because if you’re a corn farmer and you charged more than the market price no one would buy your corn. Additionally, no one would charge under market price because producers are coming in and out so frequently that there is no way to “grab marketshare” or undercut your competitors.
Grocery stores fit more into the monopolistic competition framework, which is effectively a kind of perfect competition where products aren’t entirely fungible. Fast food is an easy example of monopolistic competition. Nearly all firms produce some kind of burger, but Mcdonald’s has their own monopoly on the Big Mac. Still, these firms are ruthlessly competitive and thus charge similar prices. If there are only a few fast food restaurants in a city and they start marking up their products, they’ll quickly find more fast food chains entering the market to undercut their overcharging of products.
So how does this relate to inner city stores? Well, suppose the corner store in an inner city neighborhood is charging twice as much as the suburban Walmart, and they are making a huge profit off it. Does the system just stay as is? Obviously not, and this is where the crucial point comes in. Many critics of capitalism have not fully been taught how capitalism works. Too often, pro capitalist individuals say, “Well the price is what it should be because of supply and demand.” And usually that’s not wrong, but it also doesn’t show the skeptic why capitalism is so effective.
While we can’t quantify everything, the theory about markets isn’t a complete black box of vaguely specified supply and demand. Playing out the scenario of a store will show us the benefits of competition and capitalism.
At the Safeway that I work, a standard 12.5oz bottle of Jarritos Mandarin goes for $1.29. Let’s say that the “exploitative” inner city store store sells them for $5—an insane price. What would happen in the area? The answer is someone would soon make their own store. They would charge $4 and steal a lot of business from the original entrepreneur. In response, the original store cuts the price to $3 to win back business. You can see the price is starting to come down due to competition. What if both stores kept their prices at $4? Another store would come in and undercut them. Now let’s say they keep bidding down their prices until each store charges roughly $2 per bottle, but then the undercutting stops. Aha! Oppression! The price is now $2 in the city but still only $1.29 at the suburban Safeway! The instagram post was right! Or was it?
If prices stabilize, this means the firms are operating at the standard rate of accounting profit, making no economic profit. Economic profit is different than accounting profit. Economic profit is the profit made minus the opportunity cost of the next best business. If an entrepreneur can make $6,000 in monthly profit owning a store that sells shoes, but starts making $10,000 selling Jarritos, they’ve made an economic profit of $4000. Ine of the key insights of perfect competition is that there is no long run economic profit. This is intuitive. If you can make $10,000 selling Jarritos but only $6,000 selling shoes, shoe sellers will convert to Jarritos venders until the prices are driven down to the point where the profits from selling shoes and Jarritos are the same.
The implications of this are that the stores selling Jarritos for $2 are up against the natural level of profit. Any more price cuts, and it would be more profitable to do other things. This would push vendors to stop selling Jarritos and move back to shoes or another industry (remember, selling shoes is just an arbitrary thing, it could be any industry.)
So, the difference in price from the suburbs and the inner city shops must be coming from the costs. Pretty quickly, the pieces start to fit together. An inner city neighborhood with high poverty might have higher crime rates. This would force the shop to spend more on security. Insurance against theft or damage is likely to be more expensive because of the location. The biggest reason for the cost disparity is that inner city areas don’t have the space for large stores, so vendors are forced to selling in small corner shops. These are far less efficient because they lose advantage of the economies of scale that places like Walmart have to make products cheap.
When imagining a market as a place with aggressive entrepreneurs looking to grab profit wherever an industry slackens into largesse and overcharging, it gives someone greater clarity about how capitalism works. This doesn’t apply to every industry, as intellectual property and branding make it more difficult to undercut or mimic a brand—Jordan 1s and Reeboks are both shoes, yet Jordan’s go for $200 while Reeboks sell for $35. But these rules are strong in industries where fungible products are being sold such as grocery stores, fast food, and agriculture.
It’s important to acknowledge the different economic situations faced by individuals and groups of people. Using capitalism as a scapegoat for the world’s problems is lazy, and an archetypical practice of slacktivist Instagram.