If you've been to business school, you know that all those different classes for various business subjects are interrelated. For instance, micro economics is certainly related to marketing. Generally, prices are set in the marketing department in a corporation. How are those prices determined? If you are a Marxist and don't believe in the laws of supply and demand, then your answer might be that "the manufacturing and production costs are simply marked up to provide a fair profit." On the other hand, a capitalist would say that "the price is determined by the intersection of the supply curve and the demand curve to create equilibrium." So, which is right?
Seeing that I'm a capitalist, I've got to go with the latter. What's wrong with the Marxist point of view? Well, what happens if you set the price too low and create a demand that is greater than the available supply? The answer is a shortage. You go to the store to buy an item, and it's not there. You place one on order, and it doesn't show up for weeks or months. Can the price be set too high? Absolutely. If the price is too high, the volume of sales won't be great enough to use up all of the production. Inventory will grow, and production will likely need to be reduced. Since there are fixed costs that occur regardless of the production volume, the cost per unit will go up and reduce the profit margin for the manufacturer or the retailer or the service provider.
This talk of fixed cost brings up an issue with the Marxist idea for pricing. When you are trying to decide how high to set the price of your product, what is the cost? You have the variable costs of labor hours and material required to make the item, and those are relatively easy to attach to a unit of production. However, the fixed costs can't be allocated per unit unless you know how many units are going to be sold. Of course, Marx solved this issue by advocating that investments in machines and buildings and many of the sources of this fixed cost shouldn't be considered in the cost. Those investments should be made by the rich people out of the goodness of their hearts.
By the way, a lot of people who believe that price is somehow a simple mark-up of production cost don't consider themselves Marxist or socialist or communist. They simply think that the laws of supply and demand are just things in a text book, but they aren't actually put into practice in the "real world."
OK, let's get back to setting the prices. Those marketing guys are out there trying to figure out where to set the price in order to match demand with the available supply. They are taught to do this in a way that maximizes profit. Before you liberals have a cow, let's consider if this is a good or bad thing. This market pricing is determined by a number of factors. First, how do the consumers value one particular product? Do they all value all products the same? They do not. Different features have different values to different consumers. Just thinking of cars, do soccer moms value a 2 ton pick up the same as a construction worker? No. Do young males value a fancy sports car the same as your average retired woman? Probably not. The trick with marketing is to set the price at a level that captures enough consumer demand to sell all of the units being built. The demand can vary with economic conditions and interest rates and other things, so sometimes rebates or incentives are used to help move excess inventory.
Where does cost come into the picture? The manufacturing costs simply determine how much profit you can make when selling at the market price level. If your profit is too low, it is likely that you will do something to bring profit up. That might be done by purchasing equipment that produces more items per hour. You might develop a new technology that eliminates material cost. You might even design an alternative, similar product with fewer features and a lower cost to drive volume up and reduce the fixed cost per unit. Unfortunately, you might reduce labor costs by moving production to a low cost country. (I really don't like this one. After all, I'm an American. I have worked in manufacturing all of my life, including my summer jobs in high school and college.) The other alternative is to simply exit the market and use the resources freed up to invest in something else that returns an acceptable profit.
Now let's consider the situation that seems to worry liberals so much, high profit margins. In fact, business is accused of making too much profit far more often than it actually happens, but that aside, what happens if a product is producing a very high return on investment? Obviously, the company will want to increase production to make even more profit. Other companies that see the prosperity opportunity will also enter the market, increasing competition. As the increased supply from this company and others comes on line, the supply curve will shift up or to the left. That's kind of technical sounding, but what it really means is the price will need to come down to entice more consumers to buy the product. The equilibrium between supply and demand will occur at a higher unit volume and lower price. Additional production will continue to be put into service until the excess profits have been driven down to just that fair or acceptable level.
Does all of this benefit the consumer? Absolutely. The prices of the things they want are driven down as low as possible. The manufacturers will continue to try and out perform the competition until the consumer gets excellent quality with energy and material efficient production. Consumers also have the option of choosing a higher priced American product if they value patriotism. If production is driven out of the country by low cost, off-shore competition, it is only because the consumer made the choice for price over patriotism. I'm not one to judge you, but look in the mirror and think back to a time when you had this choice. Which did you choose? Are you one of the people that caused manufacturing to move out of the country?
What does all of this have to do with the subject of this post? Do tax incentives really work? Do they do anything? They do have an effect, but I suspect it isn't what you expected. When the government offers you a tax credit for buying a high efficiency furnace or heat pump, does that encourage more people to buy them? The laws of supply and demand would say no. The equilibrium point between the supply and demand curves doesn't change. If the tax credit really reduced the price by 10%, then demand would increase, but the supply wouldn't be there. So the manufacturer or dealer or both would have to raise the price before the tax credit. That will make the price exactly the same with the tax credit as it had been without it. Will that help get more people to buy energy efficient furnaces and heat pumps? Yes, but indirectly. You see, the manufacturer will be making more profit at the higher price created by the tax credit. That will incentivize them to increase production until the profit margin is back down at the acceptable level. Of course, tax credits like this could go away at any time. So, what if the credit goes away next year, and you have increased manufacturing output? You will end up laying people off or making lower profits. Most likely, the manufacturer will just take the windfall profits to the bank until the tax credit goes away.
What is the end result? The manufacturer makes extra profits. The government collects less tax dollars. All the liberals feel good, because they supposedly did something to help mother Earth, and they can complain about excess profits. And most important of all, the MessAPolitico just keeps rolling along.
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