The importance of consumer satisfaction—which I have referred to as Consumer Sovereignty—plays a critical role in the behavior of all actors involved in the structure of production. Miners, manufacturers, distributors, and retailers will all try to lower their costs so they can pass the saving on to consumers.
To understand this tendency, let’s examine the behavior of a single person acting as both producer and consumer. If we watch a man—we’ll call him Joe—cooking his own dinner, he will not spend more time, use more utensils, or include more ingredients than he needs to prepare the meal he desires. If the normal cooking time amounts to half an hour, Joe will not continue cooking for two hours. Of course, he does not want to burn his dinner, but, even if burning were not a risk, he wants to eat so he can get on to other activities.
If Joe enjoys cooking so much that he starts a restaurant, he will face a similar challenge in satisfying his customers. To have a successful restaurant and stay in business, he must keep his costs lower than his prices. Also, lower prices will generally lead to more customers. Thus, to have lower prices and more customers (and stay in business), Joe has a natural pressure to keep his costs low.
Of course, wages make up part of the operating costs of a business. The downward pressure on costs creates downward pressure on wages.
The reduction of all costs, including wages, occurs as a natural outcome of satisfying the desires of consumers.
Does all this mean that Joe should lower his prices to near zero and force his worker to work for close to nothing?
Running a business requires considering more factors. For example, Joe’s restaurant seats only 35 people, so what benefit does he achieve for lowering prices and costs to gain more customers?
I will look at price setting next.