A couple of weeks ago President Jacob Zuma was widely quoted as having said that he refused to accept that the value of a product was "only" determined by supply and demand. After all, it’s human labour that makes the difference and thus should determine the value of goods and services.
Well, I can sit my whole life in the basement trying to come up with the best-ever origami piece. It will mean nothing in terms of market value if nobody buys it.
Marxist labour theory always has been a tempting policy instrument, but from an economic viewpoint it’s just plainly wrong.
Now Neva Makgetla has put forward an astonishing claim in her column (Monopoly power needs policy solutions, February 14): "In a competitive economy prices should be determined by the cost of production…. That is how competitive markets push producers to reduce costs." While Zuma forced us into a time travel trip back to the late 19th-century economics of Marx, Makgetla now takes us back even further, to the early 19th century of David Ricardo, the time when mercantilism was finally buried after 300 years of adverse results — protectionism and monopoly power granted by governments.
To be clear, Ricardo was a free market adherent in the best liberal tradition, but he did not understand that prices are never determined by costs but solely by consumers’ willingness to pay for the respective goods and services. Hence consumers’ preferences determine the subjective value of a product and consequently the price consumers are willing to pay. Costs, on the other hand, determine the entrepreneurial profit. If costs exceed buyers’ willingness to pay, the entrepreneur has to produce at a lower cost or file for bankruptcy. It is at this junction where demand meets supply in competitive markets: consumers want to buy products cheaply; entrepreneurs have to be innovative to produce the same or even better products at lower costs. This should be undergraduate stuff.
Worse even, on monopolies Makgetla represents the widely held view that monopolies are dangerous and that governments shall tackle monopoly power.
Every new market begins with monopoly. Microsoft invented Windows and the MS Office applications suite. It made and still makes huge profits because buyers have a high willingness to pay and Microsoft keeps on improving its products. Everybody is free to buy Apple or Linux software packages, yet still Microsoft is the dominant player.
Is this dominance a problem? Not as long as markets are contestable and no undue (legal) barriers to entry are erected. As long as markets are open to new entrants there is no problem with concentration.