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The Economics of the Just Price

By Dr. Hassan Shirvani —

The concept of the “just” or “fair” price is as old as History. To combat predatory lending practices, price gouging, profiteering, and price discrimination, many governments throughout history have passed laws to protect their citizens against dishonest and unethical lenders and sellers. Thus, the Babylonian king Hammurabi (1792-1750 B.C.) had set just prices for numerous goods and services, including grains, cattle, boats and services of farm hands. Similar price ceilings and floors were also in wide use in ancient Egypt, Persia, Greece, Rome, and Medieval Europe. Even in our own time, the idea of the just price is commonplace, as evidenced by the prevalence of laws establishing rent controls, minimum wages, and prohibitions against usury, scalping, etc.

But how do we determine the just price for any given item? Is it the price that the market will fetch at any point of time? Or is there something fundamentally unjust about the arbitrariness of such market prices? While there has been no shortage of attempts over the centuries to answer this question, it was only during the last one hundred years that economists finally managed to provide a relatively satisfactory solution to the problem of the just price. According to this solution, the just price is simply the production cost of the item in question, provided a number of important conditions are met. First, the relevant factors of production must be clearly identified. Second, all the product and factor markets must be perfectly competitive, that is, no single buyer or seller should have control over the price. Third, there should be no market failures associated with the presence of externalities and economies of scale. Under these very restrictive conditions, the cost of producing any item will then consist of the sum of labor and material costs, interest expenses (should production take time), and profits (should production involve risk). In addition, while market prices, which reflect the short run shifts in demand, can temporarily deviate from their production costs, they will eventually settle at these costs in the long run.

The above solution to the problem of the determination of the just price also sheds some light on why it was such a formidable task for earlier thinkers to come up with an acceptable solution. In particular, we can mention the works of Aristotle and his disciples, such as St. Thomas, who despite heroic efforts, nevertheless came up short. The fact is that before the rise of capitalism in the 16th and 17th centuries, the primitive nature of both the labor and capital markets prevented the emergence of meaningful prices for these factors of production. Throughout the ancient times, slaves provided free labor services to their land-owning masters. Likewise, during the middle ages and even up to the middle of the 19th century, serfs and other sharecroppers played a similar role. Under these conditions, there were no explicit market prices for labor services. In a similar vein, given the widespread aversion to the payment of interest on loans, there was no way to incorporate interest payments as a part of production costs. However, with the rise of capitalism, where artisans and factory hands were offered wages and the payment of interest on business loans was allowed, the concept of total cost as a relevant element in the just price gradually gained ground. Finally, in the last century, economists began to treat risk as another input in the production process, thus including risk premiums as justifiable additions to production costs. At the same time, and despite these improvements, the conditions required for the just price to hold are too restrictive to render the concept too useful for everyday transactions.

Hassan Shirvani, Ph.D.
Professor Cullen Foundation Chair in Economics

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