Chapter: 15

Price Regulations: Shutting Off the Lifeblood of the Economic Circulatory System

Introduction

The subject of prices has engendered a vast economic literature of theory and opinion as well as conflicts of vision about the way society should operate. Beginning around the time the United States came into existence with the American Revolution of 1776 there has been a dichotomy between those sympathetic with the idea of a total free market economy and those who prefer state control of economic life. At the polar opposite ends of this debate are the ideas of economist Adam Smith (1723-1790), who advocated a totally free market 105and the ideas of Karl Marx (1818-1883), the socialist political philosopher who advocated state central control of all aspects of economic life. 106

Andrew Galambos’ teaching, and this book, espouse the view of prices originated and developed by members of the Austrian school of economic thought, such as Carl Menger (1840-1921), Eugen von Böhm-Bawerk (1851-1914), Max Weber (1856-1920), Ludwig von Mises (1881-1973) and Friedrich Hayek (1899-1992). That is:

The most efficient and socially desirable exchange and use of resources can be achieved and maintained only through the price mechanism operating in free markets.

Under capitalism, individuals’ subjective evaluations and preferences are expressed in their decisions about price and value. Such decisions are made constantly when people decide what to buy and sell and at what price in everything ranging from the most mundane, such as choices made in the grocery store to the most profound, such as where to live.

In free market exchanges, prices convey information about the abundance and desirability of resources which in turn allows changes in price that prevent shortages and surpluses.

Without interference of the state price volatility would be smoothed out by fast acting market feedback cycles driven by profit-loss at every node of the economic network down to the least critical node. In fact, all economic boom and bust cycles are caused by state control of the money supply and financial markets. To read about how actions of the state precipitated and then aggravated the Great Depression, please refer to the chapter entitled The Great Depression and its aftermath–a fundamental change in America. 

When price-driven decisions are allowed to operate in every aspect of the overall economy, price fluctuations are damped down by individuals in their roles as entrepreneurs, producers and consumers seeking the best value according to their subjective determination.

The following analysis of the laws of the U.S. regarding prices is based on the teaching of Andrew Galambos and his espousal of the free market ideas outlined immediately above. These ideas also underlie the presentation in Chapter 10 herein, entitled “The True Democracy of Voluntary Exchange.”

State Micromanagement of Prices in Business

Founded in 1914, the Federal Trade Commission (FTC) is authorized to issue orders to corporations to cease and desist trade practices that the FTC considers unfair. The federal Clayton Antitrust Act of 1914 gives the Federal Trade Commission authority to stop supposedly anti-competitive practices at their inception.

A&P

The Great Atlantic & Pacific Tea Company (A&P) became the first large grocery chain business, by offering groceries at lower prices than most of its competitors. Founded in 1859 in New York City, A&P is considered an American icon. The Wall Street Journal, in an editorial on December 10, 2010, said that A&P was as well known as McDonalds or Google is today and that A&P was Wal-Mart before Wal-Mart. . . From 1915 through 1975, it was the largest food retailer in the nation (until 1965, the largest US retailer of any kind). 107

The low prices and far-flung operations of A&P made it hard for small, independent grocery stores to compete. Congressman Wright Patman of Texas introduced legislation in 1935 that would have put A&P out of business. Although that proposal was rejected by Congress, it appears that the dominance of A&P was a principal reason Congress enacted the Robinson-Patman Act a year later in 1936, which requires that a seller offer the same price terms to all customers. The purpose of Robinson-Patman is to outlaw the practice of large retail chain stores negotiating lower unit prices from suppliers.

The ostensible purpose of the Sherman Act is to protect consumers by outlawing monopolies in order to promote competition. The actual purpose of the Robinson-Patman Act is to protect businesses from competition with each other.

The Clayton Antitrust Act of 1914 originally stated that nothing in it shall prevent discrimination in price on account of differences in the quantity of goods sold. That changed with enactment of Robinson-Patnam in 1936. Robinson-Patnam specifically prohibits quantity discounts.

In 1941, following U.S. entry into World War II, President Franklin Roosevelt issued an executive order placing many large companies off-limits to the federal antitrust lawyers because of defense priorities. 108 Turning to the grocery industry, federal antitrust lawyers charged A&P’s senior executives with restraint of trade, requesting criminal convictions from a federal judge in Dallas, Texas. According to Harold Fleming in his treatise on antitrust laws,The prosecution claimed that A&P had an unfair competitive advantage because its efficiency allowed it to charge lower prices. The prosecutors sought to break up the company. [A] victory by the lawyers would [have meant] the end of the high-volume, low-margin, hard-hitting, penny-saving methods that A&P pioneered.” 109

The federal judge handling the A&P case in Dallas thought the state’s case was weak. Therefore, in 1944 the prosecutors withdrew the complaint, but on the same day they filed the same charges in federal court in Danville, Illinois. The case dragged on for another nine more years before it was settled in a 1953 Consent Decree requiring A&P to shut down its produce brokerage business. A&P directors filed for bankruptcy in 2011. 110

Whereas the Robinson-Patman act prohibited quantity discounts, the FTC decided that it was illegal for a manufacturer to charge the same price to all customers across America, stating that this was prohibited price discrimination because it necessarily costs more to deliver goods 1,000 miles away than fifty miles away. In other words the FTC required a seller to charge a distant buyer more than a nearby buyer because the nearby buyer was not receiving the benefit of the lower shipping cost. The Supreme Court agreed, saying the law does not permit a seller to use a sales system which constantly results in his getting more net income from some customers than from others, for the same kind of goods. 111

The FTC has continued to attack quantity discounts. In 1988 the FTC charged six large book publishers with violation of the law by selling books to three large bookstore chains at prices lower than the prices charged to independent booksellers. All three of the large bookstore chains have since gone out of business, 113 in large part because they were not able to operate conventional retail bookstores profitably in competition with the lower prices charged by Amazon.com and other companies selling books over the internet.

Two recent cases, one against 3M Corporation and the other against Apple, Inc. illustrate that the Department of Justice and the FTC continue to harass companies for doing business in ways that the antitrust lawyers find objectionable, even though these business practices do no harm to consumers or may even benefit consumers.

Amazon, Apple and Electronic Book Readers

In 2007 Amazon.com released its Kindle electronic book (e-book) reader. The Kindle was enormously popular from the outset; several million were sold within the first five years of introduction of the product.

In 2010 Apple, Inc. (Apple) introduced its iPad tablet computer. In addition to many other capabilities and functions the iPad can be used as an e-book reader. In April 2012 the antitrust division of the U.S. Department of Justice commenced an antitrust prosecution of Apple and five book publishers charging that they conspired to fix the price of electronic books (eBooks) in violation of the Sherman Act.

Up to the time of initiation of the antitrust case against Apple, Amazon’s practice had been to negotiate discounts from publishers’ regular wholesale selling price to conventional book stores in order to offer all e-books on its Kindle to the public at the fixed price of $9.99.

When Apple introduced its iPad tablet computer in 2010, it entered into agreements with book publishers under which the publisher sets the price it shall receive for each e-book sale. Apple then sets a total selling price that is divided 70% to the publisher and 30% to Apple. The agreements also specified that the publishers would not sell e-book rights to anyone else at a lower price than to Apple. Apple’s e-book retail prices ranged from $5.95 to $14.95 per book from the date of introduction of the iPad to the initiation of the federal anti-trust prosecution of Apple and several book publishers.

In April 2012 the U.S. Department of Justice issued a press release saying that it had filed a civil antitrust suit against Apple and five publishers to prevent restrictions on price competition in the sale of e-books and that three of the publishers had already settled with the DOJ. According to the press release the Attorney General (head of the DOJ) asserted that “. . . as a result of this alleged conspiracy . . . consumers paid millions of dollars more for some of the most popular titles.” 116

In this prosecution the DOJ asserts that the publishers banded together to resist Amazon’s policy of dictating a price of $9.99 or lower for e-books sold through Amazon. According to the DOJ, the five publishers colluded with Apple to sell e-books at prices above $9.99. The publishers challenged Amazon with an ultimatum: let us price our e-book releases. Because the five publishers collectively represented nearly 50% of Amazon’s e-book sales, the DOJ complaint reports that Amazon yielded to the publishers’ demands within two days and allowed the publishers to sell the e-book version of bestsellers for prices above $9.99.

The DOJ complaint alleges that the actions and agreements of the publishers and Apple violate the Sherman Act, which was passed in 1890 ostensibly in order to protect consumers by preventing arrangements designed, or which tend, to advance the cost of goods to the consumer.

The actions of the publishers and Apple were certainly arrangements designed, or which tend, to advance the cost of goods to the consumer. Their arrangements broke Amazon’s $9.99 price cap and enabled publishers to sell e-books at prices higher than $9.99. For Apple, their agreement with the publishers continued the company’s established practice of selling music, video games and software applications for the use on Apple devices. 117

The United States Department of Justice (DOJ) is trying to force authors and publishers to sell books through Amazon at $9.99, despite the fact the market could justify a higher price for particularly popular titles that might sell in tangible form at a price considerably higher than $9.99.

In prosecuting this case the DOJ has disregarded the real world of book pricing for tangible books (hard cover and paperback) in conventional book stores and over the internet, where books are not all priced the same, but are priced in accordance with the free choices of market participants. One can buy new or used printed books in conventional book stores and on the internet for any price that the seller decides will induce sales. On Amazon.com itself one can buy hard cover and paperback books, new and used, at prices ranging from $0.99 to more than $100.

It is bizarre that the DOJ is, in effect, telling authors and publishers that there is a $9.99 price ceiling on their creations and products. Why should that be? The publishers and authors are not holding a gun to anyone’s head and forcing them to buy e-books. If readers choose to pay more than $9.99 for an e-book that means it is to them, in their subjective evaluation, worth the price asked, or they would not buy.

No one, other than the DOJ, is forcing an author or publisher to sell an e-book through Amazon either. In a free market an author or publisher could say to Amazon that they will find another way to sell the book as an e-book. That is what the publishers did and the DOJ has sued them to prevent.

The DOJ prosecution is based on the premise that the law prohibits the publishers from bargaining with Amazon, or that if they are dissatisfied with Amazon’s pricing they must be prohibited from taking their business to Apple in order to sell their books at a higher price. Perhaps the DOJ might accept one publisher having such choices, but it objects to the publishers’ concerted action to increase their bargaining power with Amazon or take their business to Apple.

The DOJ lawsuit is based, presumably, on concern that readers of e-books will have to pay more than Amazon’s standard $9.99 per title. But where is the concern for authors and publishers? Why should they not be able to use a free market to maximize the price for their creations and publications? The DOJ wants retailers to be free to reduce the prices of e-books but does not care about allowing authors and publishers being free to raise prices if the readers are willing to pay more.

Price Gouging Laws

Between August 28 and September 25, 2005 two powerful hurricanes struck the Gulf Coast of the U.S. 118 These hurricanes caused enormous loss of life and property damage. The storms caused temporary closure of two oil refineries in the area. Gasoline prices rose not only in the hurricane damage area, but across the entire country. As people fled the hurricane area there was a shortage of hotel space in neighboring areas, and a consequent rise in hotel rates, as well as increases in the cost of gasoline, food, and other necessities of life.

Invariably when a natural disaster causes shortages of the necessities of life, politicians raise an outcry against price gouging. However, if political threats of price controls and price-gouging lawsuits prevent prices from rising at a time of shortages, it is the consumers who will suffer in the long run.

Politicians and state lawyers and regulators called for action against price gougers and for price controls in states across the country, including Alabama, California, Connecticut, Hawaii, Illinois, Michigan, Oregon and Texas. The Attorneys General of Alabama and Texas each threatened to prosecute businesses that raised their prices during the hurricane-caused emergency, apparently disregarding the fact that hotels in vacation destination areas always charge higher prices in the vacation season. Otherwise, they would have to turn away many people. 119

This might initially seem unfair, but let’s examine more closely: A higher price due to higher demand is the way a free market allocates resources during a time of scarcity. High prices during a time of shortage are the means to bring out additional supply that will reduce prices over time. The high prices are a form of voluntary, non-coercive rationing of goods and services in short supply. For a supplier of any goods or service to keep prices below the free market level due to political coercion only causes frustration to those vying with each other to obtain scarce resources.

During a time of rapidly rising gasoline prices in the 1970s the U.S. federal state imposed price controls on gasoline. Instead of prices rising until the amount people wanted equaled the amount available, chronic shortages of gasoline developed and Americans had to wait in lines for hours to buy gasoline. Yet, the shortages disappeared almost instantly as soon as price controls were removed.

At the time of high post-hurricane prices in 2005, the U.S. Congress enacted a law ordering the Federal Trade Commission to investigate whether gasoline prices nationwide were artificially manipulated by reducing refinery capacity or by any other form of market manipulation or price gouging practices by refiners, large wholesalers, and retailers in the aftermath of Hurricane Katrina. After investigation, the FTC reported that it “. . . found no instances of illegal market manipulation that led to higher prices during the relevant time periods [and that] . . . factors such as regional or local market trends . . . appeared to explain [price increases] . . . in nearly all cases. Further, the report reiterated the FTC’s position that federal gasoline price gouging legislation, in addition to being difficult to enforce, could cause more problems for consumers than it solves, and that competitive market forces should be allowed to determine the price of gasoline drivers pay at the pump. 120[Emphasis added]

For once, in the FTC report on gasoline prices, the ideas of the FTC were compatible with the economic law of supply and demand. However, generally the FTC has busied itself interfering with the operation of the law of supply and demand, as has the Antitrust Division of the U.S. Department of Justice.

 

 

 

 

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