The thought receptacle

Stephen's mental dustbin

Mon, 25 Feb 2013

Price of living

(I wrote this some time ago, which probably shows, but it still seems worth posting....)

“Cost of living” is a phrase I've heard a lot in the last year or so, both when talking to friends about their moves and when considering my own potential moves. It took me a while to realise that it's a phrase that usually doesn't mean what it appears to mean. Large cities are often cited as having “high cost of living”. But the whole reason we have cities is for economies of scale! Living close together is cheap, because infrastructure costs are so well amortised. This includes utilities, transport, food supply, and almost everything else. Living in rural areas, conversely, is expensive! That's why rural post offices struggle to keep open, rural public transport is generally poor, and so on.

What people mean when they say “cost of living” is actually “price of living”. Most large, successful cities have high prices of living because they are desirable as locations. In turn, this is largely because of their high value, including social and cultural value. Among these values is the diversity of employment opportunities that a city environment can offer. This demand is exploited by land- and property-owners, who adjust their prices far above cost. High demand combined with collusion creates a lack of choice, effectively coercing people into paying their high prices, regardless of how much lower the cost might be. Cost and price are definitely not the same thing.

There's something interesting about this adjusting-the-prices phenomenon. When traders do this by explicit collusion, it's called a cartel, or price-fixing. It's clearly scurrilous and interfering with the operation of the market. But when traders do the same thing without explicit communication, but nevertheless collectively, it's called “the market”, as in the so-called property market. The net result is the same as price-fixing, so why do we treat the two cases so differently? This might be classic supply/demand economics, but it is a very different kind of market from the good kind which most market advocates like to describe. In the best examples of markets, prices are driven by cost and kept down by competition. With property, prices are driven by demand and kept up by implicit collusion.

The unhelpful response is also a predictable one: of course people will set prices as high as they can, and “there's nothing you can do about it”. I think this shows a severe lack of imagination. Our institutions of ownership, trade and pricing can all be tweaked. The challenge is to come up with the right tweaks. The overriding question in this case is: how should contention for scarce resources be resolved? At present, it is solved by “who pays most wins”. Is there some “best claim”, “means test” or other criterion we could use instead? Scarce resources in other domains are decided on merit of claim rather than depth of pocket. These domains include higher education a.k.a. university places. They also include domains where the resource being assigned is itself money, as with funding for arts or science projects. There are no doubt others. Perhaps if the same kind of policy was applied more widely, we wouldn't have the problem of colluding land barons. (Alternatively, we could try to tackle the issue of collusion head-on, which brings us to rethinking our pricing systems. That's a topic for another time.)

On the subject of policies for resolving contention, I have some ideas, but I will save them for another post. They range between the peculiar and the fantastical. So I'll stick with a more easily digested message for this post: that cost and price are two different things, and that the collusion which undermines the virtuous operation of markets doesn't have to be explicit.

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