One of the things that students learn very early on is the way the price mechanism operates to equate supply and demand for a good or service. They refer to this as the equilibrium point and according to theory, the market tends to move towards an equilibrium point thanks to the price mechanism.
Thus many people feel that the price mechanism can be the panacea of anything that is wrong with the market.
An increase in price would eliminate a shortage as it would stifle demand. A reduction in price would make a surplus disappear because it stimulates demand.
These students also learn that there are some exceptions to this golden rule. And the more advanced students learn about market failure that would justify government intervention in the market to address the negative impact of such market failure.
When it comes to practice there are a number of considerations to make, especially as one analyses specific markets. A couple of weeks ago I wrote about certain segments of the labour market.
The demand side of the market is represented by employers seeking to employ persons. The supply side is represented by persons seeking employment or to change their employment. The remuneration package represents the price.
Demand and supply decisions need to be sensible such that the market finds the equilibrium point at the right price
On this basis, the employer has the role of the buyer. In fact the recruitment operation should really be a buying operation. I pointed out that it has become a selling operation, in that employers (representing the demand side and therefore have a buying role) have had to become sellers given the skills shortage for a number of occupations.
This has rendered the labour market very unnatural. Thus remuneration has evolved in a manner that is rendering a number of businesses uncompetitive. This leads us to the title of this week’s contribution – are remuneration packages (that is the price of labour) in Malta right? Do they really reflect an effective price mechanism?
Another example is the price of property. Today we speak of a shortage of property. Is there really the type of shortage that is often portrayed? Some would say definitely not, given the amount of vacant dwellings.
In response to this perceived (and maybe unreal) shortage, prices are going up. As prices go up, there is an increased supply coming onto the market. Such increased supply is factoring in an assumption that the growth in demand of the last couple of years will continue in the future. I doubt if this will happen.
This does not mean that demand for property will go down, but it is likely to start flattening. Thus it becomes pertinent to ask if the current price for property is right and really reflects the current demand and supply situation in the market.
One may ask why such situations should give rise for concern. The answer is simple. They are not sustainable in the medium and long term. Whenever a price is artificially high or artificially low, this means that the price mechanism is not functioning effectively. When the price mechanism is not functioning effectively, economic bubbles are created.
A survey commissioned by the European Union shows strong economic optimism in Malta. We should make every effort to maintain this level of optimism as it reflects a vibrant economy. However, this optimism needs to be balanced by an element of sobriety, as it may otherwise lead to foolhardiness. We should never talk ourselves into a recession; but neither should we walk blindly into an economic bubble.
When the price is not right, we would be creating such a bubble. When it bursts, many people will get hurt. We expect the government not to intervene in the operation of the market. However, demand and supply decisions need to be sensible such that the market finds the equilibrium point at the right price.