An occasional outlet for my thoughts on life, technology, motorcycles, backpacking, kayaking, skydiving...

Tuesday, May 13, 2008

A basic lesson in economics and politics

I posted this as a response to one of many frighteningly uneducated rants about gas prices. Let me be very clear in stating that I am extremely worried about energy costs and its effect on my family. (I have started car pooling 4 days a week and working from home 1 day which is the most my employer will grant.) What I am more worried about is what the dumb masses may do in response to the stress that we are all feeling.

Dan said: "...with all the extra cash being stolen from the consumer..."

Dan, That was a pretty ignorant thing to say. Please post a link to the definition of "stolen" that applies to this situation.

What you must realize is that gouging has nothing to do with profits, it has to do with profit margins.

Let's say your business makes and sells a simple product, like slotted o-rings. You make the product by purchasing non-slotted o-rings and turning them on a lathe. You have brokered a deal with you customers that allows you to have a 10% profit margin. However, a market event has caused the cost of your precursor to double. This means that you must invest twice as much of your capital in the non-slotted o-rings in order to meet your customers' volume demands, which have not changed. Even though you are not selling any more product, you are spending nearly* twice as much each month. (*assuming that you have employees whose wages have not changed) The redeeming factor is that your fixed profit margin of %10 means that your profit nearly* doubled along with the cost of the non-slotted o-rings. At first, your customers will be upset that the cost of your product has nearly* doubled, but when they see the figures they will understand that you are not stealing additional profit. That is, unless your customers are being enticed by politicians/media and your product is a ubiquitous commodity like gasoline.

If you where forced to sell your product at the old price, you would be losing nearly* 40% and would go out of business immediately. If you were forced to lower your profit margin to 5%, you (or your investors) would likely decide that your risk is not worth the reward and choose to invest your capital elsewhere. If your customers' politicians decided to buy votes by promising to levy steeper tax burdens on your "evil profits", you would have to choose to either increase your prices or take profits away from your investors to pay the taxes. If your investors include the pension/retirement investments of virtually every single policeman, fireman, teacher, and anyone else with a lick of sense in this country (as is the case with the oil companies), those taxes on "your profits" actually end up coming out of the very people that the politicians were manipulating in the first place.

These knee jerk solutions to our energy crisis are very dangerous. People like you are going to turn this economic correction/recession into a full blown depression if you get your way. And the socialist politicians will be laughing all the way to the treasury. They will then use the taxes you demanded they take [vicariously] away from you, and use them to implement social programs to provide for you what they feel are your basic needs. From each according to their ability to each according to their need. Of course those with friends in high places will be judged to have greater needs.

Here is an interesting link about profit margins:

Update: Here is a great article on the matter, that I found after I published this article.

1 comment:

  1. Thanks for that explanation. I actually did not know this.