The Three Fundamental Costs

Let's have some economics today. I have worked out a new way of looking at the economic system.

Prices in a free-market economy are determined by the well-known Law of Supply and Demand. Supply and Demand is simple in principle. But analyzing just why the price of something is what it is would be a very complex and daunting task.

Let's see if we can simplify it. Our goal here is to be able to explain exactly why the price of something got to be what it is.

We know that all molecules can be broken down into a relatively few component atoms. On my patterns blog, http://www.markmeekpatterns.blogspot.com/ , I showed that all patterns in the universe can be broken down into four fundamental patterns that I named "primes".

Now, I have noticed that the Law of Supply and Demand can be broken down into what I have named the "Three Fundamental Costs". The cost of anything, as determined by the Law of Supply and Demand, can be broken down as: The Cost Of Land + The Cost Of Transportation + The Cost Of Communication.

The first of the Three Fundamental Costs is the Cost Of Land. Everything that is produced is produced on land and may involve materials that are taken from the land, so that the cost of land finds it's way into other costs. The cost of land is primarily a function of population density. This is why prices are higher in cities than in rural areas, the high price of land finds it's way into the prices of everything else.

The cost of a building used in production is a function of the cost of land both because the building must occupy land and because the building materials used in the construction are taken from the land.

The second fundamental cost is the Cost of Transportation. Anything that is produced must be moved to where it is consumed. The cost of this movement effectively becomes a part of the cost of production. The Cost Of Transportation is less fundamental than the Cost Of Land because the cost of the vehicles and fuel used in transportation is partially determined by the Cost Of Land.

The Third Fundamental Cost is the Cost Of Communications. It is necessary to communicate readily over a distance to set up trade and business deals. The great benefit of the internet is that it has drastically reduced the cost of communications.

It is technological progress that determines both the Cost Of Transportation and the Cost Of Communication, which makes these two fundamental costs less fundamental than the Cost Of Land.

The price of any good or service can theoretically be broken down into these Three Fundamental Costs, plus the profit margin.

This model is somewhat more flexible than it may seem. The Cost Of Land is not, in itself, entirely fundamental. The primary value of real estate lies in it's location, and that value can change for any number of reasons. Natural resources that come with land add to it's value, but the value of those resources are shifting.

As I pointed out in the posting, "The Wage And Price Disparity" on this blog, the wages of those workers who are not engaged in work that actually produces anything are an effective cost of production as a whole and drive up both wages and prices.

The cost of manufacturing, other than land, cannot be considered as a fundamental cost because it must reach an equilibrium with wages so that people who work will be able, as a whole, to buy the products that they have made. The Three Fundamental Costs are not a part of any such economic equilibrium.

The cost of labor (labour, I will alternate the two global spellings of the word) in production makes up the majority of the cost of many goods and services. It may seem at first consideration that labor should be considered as a fundamental cost, but it isn't. The cost of labour is primarily determined by the wages that workers need to live on in a given area. Wages and prices reach an equilibrium.

The cost of labor certainly goes into the costs of the goods that are produced by the labour. But yet the cost of the labor is also determined by the cost of the goods. If shoppers have money, the prices of goods will rise. If shoppers are short of money, the prices of goods will drop according to the Law of Supply and Demand.

So, the cost of labour is actually no more fundamental than the cost of goods and services. Since the costs of goods and services rests on the foundation of the Three Fundamental Costs, the cost of labor must also rest on this foundation and is not, in itself, a fundamental cost.

The cost of labour also includes the cost of the skill that goes into production. This skill application can be either direct, by the skilled labor of a person, or indirect, by the skill built into a machine or software. But regardless, the cost of labour can never be a fundamental cost because it must form an equilibrium with the costs of goods and services, which rest on the fundamental costs.

In conclusion, a practical model of a free market economic system is the wage-price equilibrium resting on the foundation of the Three Fundamental Costs. "Fundamental" meaning not a part of any balance-seeking equilibrium process.

By the way, the Obama Administration recently took the advice that I posted in "Recessions Made Really Simple" on this blog. Well, I cannot say for sure that they got the idea from my blog. But my suggestion about manipulating payroll taxes to be sure that there is enough money in circulation to buy all of the goods and services that are being sold was implemented into the tax code.