Robes that Obscure Supply and Demand

I don’t presume to be an expert on economics. I have a BA on the topic, which is as far from being a full-fledged economist as someone with a BS in biology is from being a doctor. That said, the ruling this week by the Supreme Court that overturned a 96-year precedent against creating price floors is a horribly misguided economic decision.

Let’s set aside, for now, the knee jerk reaction to the verdict, which seemed a gross violation of stare decisis, which Chief Justice Roberts seemed to believe so strongly in during his confirmation hearing. I definitely have an axe to grind with what appears to be wanton dishonesty, but that is a topic for another post. This post is all about economics. If you aren’t comfortable with economics, don’t worry, I’ll go slow.

Ok, first, what did the ruling change. As part of the Sherman Anti-trust Act, which is largely the cornerstone legislation that prevented monopolies from forming in the United States, a manufacturer could not regulate the price a distributor (retailer is a better word) charged for the good. This is manifested in that ubiquitous The Price Is Right phrase, “The suggested retail value is…” I added the emphasis because a manufacturer, prior to this ruling, could only suggest a price. This is inline with the way the market typically would run. A manufacturer sells a retailer their product at some wholesale price. The retailer then sets a price that will translate into profit for that particular retailer.

In this case Leegin Creative Leather Products attempted to cut off sales to Kay’s Kloset, a retailer that refused to honor Leegin’s no-discount policy. The precedent, set in 1911, ruled that there could not be a pre-set retail price set by the manufacturer and the distributor because this arrangement could only serve to benefit the manufacturer and the distributor, but not the consumer.

The argument, coming from apparently the Chicago school of economics, which was really founded by Milton Friedman and his writing on the preeminence of monetarist thought, as well as, the elimination of government from the workings of the market, would suggest that price floors can increase competition. To be very honest, this seems counter-intuitive to my understanding of economics, but I will reason it out as best I can.

The argument would go something like this, I believe. In a given market there are two companies (Company A & Company B) who both produce product X. Let’s assume the two companies control the entire market on product X, with each company accounting for 50% of total sales of product X. These companies do not collude together, but rather set a price floor with distributors independently. While one could undercut the other on price, it currently doesn’t seem advantageous. Now we introduce Company C that also wants to sell product X. The people in support of this price floor would argue that this price floor allows Company C to sell product X without the economies of scale enjoyed by Companies A & B. This would result in a faster return on investment for Company C and divide the market into three, where the likelihood of price competition would be greater. Again, I don’t believe this works, as the price floor is agreed upon by the current stakeholders in the market, it could just as easily be abandoned in the case of competition.

Also, this appears to be a situation where the Chicago School, advocating for a removal of government from the market, is actually creating an artificial price level. Price floors do not properly reflect supply and demand levels. It doesn’t matter that the supply side of the market participants agree on price. This could result in a situation where, given an good that can’t be substituted, where the market is dramatically distorted because there is no supply available at the demand level reflected in the market, creating excessive profits. In this case, the judicial precedent actually kept the market operating efficiently, while at the same time protecting consumers from abusive pricing practices.

This really translates into a triple-whammy. First, the court betrayed from the principle of stare decisis. Second, the court interfered with the market and has created a situation where manufactures and distributors can collude to distort the price level. Third, the court has decided against protecting consumers from unfair pricing collusion. This is a bad omen for the future of the Roberts court. I can not agree with this decision as an economist or as a consumer. Stay tuned for the next session when, it would appear, more long standing precedents that protected you and me will be overturned to the benefit of them.