Reason for a New Age

Posts Tagged ‘pricing’

More on Pricing

Posted by publius2point0 on 2010/01/06


Continuing on from the previous two posts, I will discuss the topic of pricing and salaries further.

“Supply” is something which can generally be easily expressed. There are three t-shirts.

“Demand”, on the other hand, is generally quite unexplainable. Quantifying it as an average amount that people will pay is really the only way to express it. But what sort of logic or irrationality goes into deciding the demand for a thing is really just guesswork. I can walk you through some of the reasons why people might pay more or less for a certain thing than you might think seems reasonable, but at heart the most one can ever say about why something costs what it does is that it’s that way because that’s how the pulling forces of supply and demand judged it in society’s mind.

Let’s examine, as a test case, management. In modern society, a manager is generally paid more than his subordinates. This isn’t always the case–for instance, I’m sure that somewhere there’s some PHD biochem engineer making an astonishing salary, while some fellow who knows little more than how to balance a couple of numbers oversees him and makes some less astonishing salary. But generally it can be said that a boss makes more than his direct employees.

Argument by Scarcity
One argument for this difference is scarcity. While as anyone can shovel coal from bin A to burner B, only one out of every ten shovelers has the people skills to effectively manage. This man, finding himself to be specifically desirous and rivals in short supply can argue that it would be hard to find someone else besides him to fill the position. He would be more desirous to competitors than his fellow shovelers, for he has a skill that most do not. Hence, it is in the company’s interest to offer him enough that he will stay with them and do this work.

In this view, you could say that there are a progression of skills necessary to advance up each rank in the company hierarchy. You need to have people skills, you need to have sales skills, you need to understand the business, you need to understand the market and the customers, you need to have problem solving skills, and you need to be able to strategize. The person who has all of these skills is almost certainly in very very short supply. If you find him, you need to offer him enough to interest him in joining you as your CEO rather than that he go elsewhere, compete against you, or retire.

And of course many skills are trained. Our PHD biochem engineer is in short supply for his knowledge and for being able to demonstrate his temerity in problem solving. He also has many years worth of expensive schooling to pay for. He is not only in short supply, but also has to ask for extra money, just to pay for the education he received. He will certainly continue to look about until he finds someone willing to pay that amount, and if you aren’t willing to pay that, you shouldn’t expect to be able to find anyone of those qualifications to work for you.

The scarcity of workers of certain skills is somewhat like a union, bargaining on behalf of the whole set of workers of that class. Unlike a union though, it doesn’t require any sort of organization to run. Humans, understanding humans and the world around them, notice when they’ve attracted attention, i.e. when they are desired. A person who is more desired than the person next to him gets to ask for gifts.

Argument by Bribery
Another possible cause for this discrepancy is the perception of hassle, stress, or general undesirability of a job. You might think that this only accounts for jobs like garbage men or coal miners, but personally I would argue that this is not an insignificant factor for managerial types as well. At the lowest levels, dealing with general workers can often be like herding cats. You have to deal with office politics, petty disputes, make sure that everyone is feeling wanted, make sure that they are receiving the things that they need, and of course sometimes you have to tell someone that they’re out a job. Minus a higher salary, and especially as you’ve already saved up a decent nest-egg towards retirement, why else accept a higher–and hence more stressful–position unless someone should bribe you into it?

In a sense, this is a reverse version of scarcity. Rather than saying that there are few people qualified for a job, you are saying that there are few people who want to work this job. You have to pay them enough for them to convince themselves to forgo their basic sanity.

Argument by Production
When a person manages 10 people, their ability to perform well is affected by his abilities as a manager. A poor manager can cause the work flow to all but stop, while an excellent manager can see drastic leaps in the performance of his workers. The CEO of a company is, similarly, the difference between continued growth or the entire collapse of the business. As such you can say that, while not directly producing the goods of the business, the managerial staff is responsible for some percentage of that output. As such, their wage is simply the product of that percentile.

If 1000 worker bees make $10,000 worth of goods in a day, and the managerial staff is, overall, responsible for the complete failure or success of those products making it to market, then the entire managerial staff can be considered to be worth at least 50% of all income. The CEO can be considered to be 50% of all of the managerial staff, and so on down the line. Overall, this would work out to something like:

1000 Workers @ ($10,000 * 50% / 1000) = $5 per day
100 Managers @ ($10,000 * 25% / 100) = $25 per day
10 Section Heads @ ($10,000 * 12.5% / 10) = $125 per day
1 CEO @ ($10,000 * 12.5% / 1) = $1250 per day

Obviously, that would be after expenses.

While not a particularly realistic example, it does demonstrate that an argument could be made for this is a fair method of payment. Where such an argument can be made, it likely is a factor in the consideration of how much to pay a person. How much of a factor though wouldn’t be decided on any sort of logic like the above, rather it would be based more on gut feelings and so on.

Argument by production works more in favor of professions like money lending. A money lender doesn’t directly create nor even manage the production of goods. Yet, nevertheless, there would not be those goods if the moneylender didn’t exist. Again, how much value they add to society, in terms of production, is hard to quantify, but that they are doing something that is perceived to be of value is evidenced by the fact that people are willing to trade for it up to the amount that that person is being paid.

A business has no interest in paying a person more than they are worth in terms of making money in return. All other factors accounted for then, you would expect to match the end produce that is attributable to any individual based solely on his salary. But indeed, there are those factors, mucking it up.

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On Scarcity

Posted by publius2point0 on 2010/01/06


An item that I skipped over in my previous blog was the discussion of pricing. I said that money translates any sort of labor into any other sort of labor, but as you might note by looking around in modern society, not everyone’s labor is worth the same amount. And if everyone works (labors) for 40 hours a week, wouldn’t it seem to make sense that we each earn the exact same 40 hours worth of labor credit? Well no, because of this thing called scarcity (also known as supply and demand.)

Before talking about the economics of scarcity, though, let me first touch on the philosophy of it.

The nature of evil is tied in with scarcity. Many people think that humanity is evil, that there are demons that force us into evil acts, or simply that certain humans are evil. Yet, if you find someone who has done something that you find abhorrent and ask them about it, they will almost always feel justified in the action. And of course they wouldn’t have done it in the first place if they hadn’t felt justified at that exact moment, leaving it safe to say that everyone acts according to their belief of what is a moral thing to do, at that particular moment in time. Only retrospection can change that into having been an immoral act.

For the quibblers out there saying that “justified” and “moral” are not the same thing, let me explain further. Unless you hold that morality is black and white, rather than shades of gray, then you would agree that a moral act is anything where you have weighted things to be on the lighter half of grays. The goods of it outweigh the bads. Ergo, it is justified.

But so then, if everyone is at all times acting morally, how do we end up with “evil” acts? Well let’s say that there are only two people on a deserted island and only enough food for one of them to live. They can either both die or one of them can kill the other. Neither of these is a particularly pleasant outcome. Once starvation sets in and the instinct to survive kicks in, you can’t really blame one for killing the other. You might tsk at him a bit, of course, and it might even be that in his place you would have been able to restrain yourself, but that’s actually part of the point.

Different people are different. Our ideas of what is or isn’t morally justified, our personalities, our personal aspirations, etc. are all different. How we will respond to scarcity varies. Sometimes our individual personalities can create scarcity where there wouldn’t naturally be any. There might be a million rings that were all made in the same mold, entirely indistinguishable from one another. They are ugly, even, and basically unwanted by anyone even for their base elements. However, one of them was worn by Elvis for two seconds in 1974 and X Elvis fan must have just that one. That might mean that he will pay thousands of dollars for it, or it might mean that he’ll walk into a museum and swipe it from the display. It just depends on how much it seems worth it to him (which, again, he will only do if he finds it justified.)

Overall, scarcity creates conflict. Governance, laws, social hierarchies, moral guidelines, and standard operating procedures all exist as a way to allow the individual to achieve as many of his personal desires as he can without getting in the way of others being able to achieve theirs. Pricing is just another method that humanity has dreamed up to be able to achieve the peaceful allocation of limited resources.

Previous to the 20th century, as an example, actors were nearly unanimously considered an underclass of thieves, whores, and wastrels throughout the world. When life was so hard to live that a person had to work all day just to earn just enough food to support himself and his family for just one day, the person who ran off to wear costumes and act like a fool was hardly to be respected. Of course, you might also term this “jealousy”. These people were looked down upon because everyone else could only wish that they didn’t have to spend every day working under the hot sun, sowing seeds and harvesting crops.

Let me introduce the concept of the “food unit” as I intend to use it again in the future. More than anything else, humans need food. It takes a certain amount of labor to create enough food for a person to survive. If he can’t get that, he dies. And before modern technology came to aid, most of a person’s day was dedicated to the basic task of doing as much labor as needed to create enough food to survive one more day. 1 food unit is the amount of labor it takes to create enough food to survive for one day.

Subsistence farmers, having to make it through the winter and to support children until they are able to labor for themselves, have generally produced slightly more than 1 food unit per day. Out of laziness, they will often not produce more than enough for just that purpose. The winter is 1/4th of the year, so our farmers need to produce an extra 0.25 units per day, and to support babies and toddlers, let’s say that they will need another 0.25. In total, a subsistence farmer can be said to labor for 1.5 food units per day. Only 0.25 of that is excess, and that’s only when there are no small children about.

In this setting, less than 1/4th of all people could be actors. There simply isn’t enough food for it.

An actor cannot earn less, on average, than 1 food unit per day. If he earns less than that, he dies or–to survive–goes back to working as a farmer. But if he’s working the same number of hours as a farmer, and a farmer’s labor is worth 1.5 food units per day, then it would seem only fair that he earn 1.5 food units as an actor, no?

So you ask, is an actor a scarce resource? Well let’s say that 95% of everyone would rather be an actor than a subsistence farmer. This makes sense since subsistence farming is a backbreaking profession whereas acting can actually be quite fun. If everyone who wanted to be an actor decided to go for it, then out of a population of 1000 people, we would have 50 producing 75 food units per day, and 950 acting. 50 people making 50 food units doesn’t even support the total population, let alone making it through winter.

Now like I said earlier, the whole point of law and governance and all of that is to try and get the available resources to those who most want it while getting in the way of others as little as possible. If, in this scenario, some cruel stroke of fate decided to make the 5% who were happy to be subsistence farmers work as actors and the rest of everyone as farmers, this would be the worst possible situation. The ideal situation for the actors would be that those who most wanted to be actors were made actors. But the ideal situation for the farmers would be that those who were the most talented actors become actors. If these two groups were the same, then all would be well.

In my previous blog, I mentioned the case of Daisy, Ed, and Francis, where all of them are specialists in the manufacturing of widgets. Within that realm, however, their skills at different parts of the process might vary. The way that life is, what field of work you would like, and what your personal talents are, aren’t necessarily going to be synonymous. You might love the widget industry and want to be an engineer for it. Minus the talent to be an engineer, you will have to decide whether you would rather do another job in the widget industry, or if you would rather work on attaining some other occupation at which you would be sufficiently talented, even if you aren’t as interested in it as widget making.

This is all a balancing act. The world would be best if everyone could do what they wanted and if everyone who wanted to do something was very good at it. The world would be worst if no one could do what they wanted and if everyone was very bad at their profession. For most of history, this was actually fairly random. You were born into a family of farmers or you were born into a family of blacksmiths, or you were born to be the king. Whatever that was, you were raised to be it and you’d be lashed and goaded into performing that task. Humans as fairly malleable beings and having a tendency to gain some fondness for what they know and have experience with, don’t do terrible in this sort of scenario, but I think you can see that a better system than birth-mandate would be preferred if possible.

Given the freedom to make an attempt at another profession will almost always be a better system. Those who are interested in something will work harder to become good at it. Personal talents are, while perhaps genetically limited, malleable to at least some extent. Determining your own talents and being able to find work which matches that is, also, still better than being forced to do something which you had no say over at all.

Returning to our population of farmers then, 95% of them will consider acting. But this is on a gradient. Some of them will only slightly prefer acting over farming while others would do just about anything to become an actor. The ones who are most interested will work at becoming an actor the hardest. Of those, the ones who receive the most positive feedback from their beginners attempts at acting, will try even harder to become an actor. But in the end, only those who can earn at least 1 food unit per day from the rest of the community will actually be able to become a professional actor. Whether they can charge more than 1 food unit depends on how many farmers decide that they can safely part with their excess, whether they personally have any interest in seeing a play, and whether they believe that the play will be sufficiently enjoyable as to part with their food.

Like I said, the practicalities of the situation is such that less than 1/4th of everyone can become an actor. But once you weigh in all of the other factors, it may be that only one in every thousand people can successfully make the jump and he may be forced to work for exactly 1 food unit and/or even have to work longer days than farmers do to earn it. If you say that this isn’t fair, then I’d have to wonder what better solution there is, given the scarcity of things and individual talents and desires? There may be such a system, but as of yet we haven’t found it.

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