Price Action Changes Human Behavior

A critical concept of economics is that price changes behavior. At least in the classical school, investors are assumed to be rational. This means that people make decisions in their own self interest, and try and maximize their “utility”.

We are starting to see the real economic effects of prices. Take the cotton market for example. Prices surged last year because of the drought. It wiped out all worldwide crops except those in the US. This year, cotton farmers are increasing the acreage they are planting in response to the higher price.

Meanwhile, the higher price is changing business decision making too.  Garment manufacturer Hanes is investing in new technology that will convert flax fiber into material for clothing.  If it works, it will lessen the amount of market risk Hanes has, because they will have diversified 20% of their raw material costs.

If we get good weather, and a good crop, along with differentiation as businesses and people try substitutes, the price of cotton should drop.

This is all done in real time.  It’s also why the market is a much better determinant of action and reaction than a central planner sitting behind a desk.  Markets allocate capital faster and more efficiently than government bureaucrats.  Remember that the next time someone asks for a tax increase.  Higher taxes will cause people to choose the behavior of less work, and making less income.   That means lower production and lower GDP.

This isn’t rocket science.  People are rational.

Read more at Points and Figures