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Bottom up vs. top down viewpoint

Another way to explain how companies cannot determine the wages they pay is by looking at the direction in which the control moves. Most people see their boss and their company as being in control of wage setting. They decide what their limits are, but so do you:-) They have to react to the labor market, the labor market does not respond to them. The same applies to what companies charge for products or services, they have to price according to the market.

If the company ignores market prices for either products or wages, weird things start happening. We all know what happens if they price their wages far below the labor market or if they price their products way above the market value, nothing. Laborers and consumers will stay away in droves. What happens if they go the other way? What happens if they price way below market value or hire way above going rates? In the example of products being much cheaper, it’s pretty easy, they sell more. That isn’t necessarily a good thing though. They make less on each product they sell of course, but their costs could also go up with a big enough volume. Usually, production costs start out very high for small quantities of products made and drop as you make more and more. This is primarily due to economies of scale (better prices from suppliers, maximization of usage of facilities, etc.). If you keep going up in volume, prices to manufacture per unit will eventually go up as you max out your factories capabilities, have to pay more overtime etc. The upshot is that companies will set their production so that they manufacture at the lowest cost per unit thereby maximizing profit. If they start selling more due to price reductions, not only will they make less per unit but they’ll also pay more per unit to make the things.

Pricing wages above going rates also causes problems. The biggest one being that the company cannot afford to hire as many people. This in turn means that their maximized profit production has to be with fewer items made and that equals even less money for the company. Not only that, it means higher prices and/or fewer products for the consumer because of reduced productivity and higher prices that are usually required to maximized profit. Usually the argument about raising wages (and benefits are just another form of compensation) is talked about the most when it comes to low paying jobs and especially in third world countries. Here’s the thing, higher wages means less employment and higher prices. Both of which hurt the poorest far more than what the few lucky workers gain. I’ll talk about how raise living standards and wages in another post.

The markets for goods and services are made up of all of the transactions that occur all the time. Price changes up and down are out of the control of individual firms and individual workers. There’s a reoccurring myth that corporations are controlling the world through wage and price setting. There’s another popular myth that workers need to be protected from corporations “greed”. It is the quest for profit that employs all of us and produces all of the products and services we consume. Prevent prices from being set at market levels at your own risk…

Isaac

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