Obama's Lemonade Stand

I remember a Dennis the Menace comic strip from my childhood.  It had Dennis at his lemonade stand, with a sign that advertised $5 a cup.  The caption said "I only need to sell one."

Price management is one of the most difficult and most important task of any business.  I've worked in the retail industry most of my career, so that's the example I'll use.  The business' number one task is to earn a profit for its shareholders.  It seems like a simple concept, sell your product for more than you paid for it.  The difficulty comes in trying to decide how much more.  At my book store, it was fairly simple.  I bought used books from customers for 25% of retail, and sold them for 50% of original retail.  It was a nice margin, and the store was in business for more than 25 years.

If you have read the Joseph Heller classic, Catch 22, you will remember the supply, clerk Milo, who bought cotton stock for 50c a share and sold it for 25c, "but we are making up for it in volume."

With the rental car company, I learned yield pricing management.  I had to look at reservation demand, car availability, and competition prices and set our prices to get the highest possible revenue from each rental, without running out of cars.  For example, on a Monday we would have high rates because that's the day most business travelers would arrive.  Tuesday's rates might be higher still because we would have fewer cars available, and so would our competition.  By Wednesday evening, rates would go down because we would have more cars returning than being rented.  By Friday, rates would be extremely low for cars that would be returned in time for the Sunday evening rush.  So, it's a little more complicated than "buy low, sell high."

In general, there's a curve graph of profitability.  Starting with a price of zero, where of course you lose money; to a price of, I guess, infinitely high, where you would still have a loss due to no sales.  Somewhere in between you have a maximum profit.  For example, at Stride Rite, a style might make the company a profit of $500,000 with a retail of $49.99.  Raise the retail price to $59.99 and you get more profit right?  No, because then the customer does not see the value of the shoe and chooses a cheaper competitor's merchandise.  So a higher retail price might earn a lower profit.

The same applies to our federal taxes.  Former Reagan adviser, Arthur Laffer devised the Laffer Curve.  His studies show an optimum tax rate, similar to the curve you see in retail pricing.  At its most basic, government provides services for a fee, your taxes.  While we still see some value in the service, Americans are willing to pay the fee, and revenues rise.  At some point, the fee becomes  too high for the perceived value and Americans become less productive, resulting in lower revenue.  For example during World War I, President Wilson's administration needed more and more revenue to fund the war and the explosion of federal programs instituted under Wilson.  They created more and higher taxes, targeting businesses and the wealthy.  The more taxes they imposed, the less revenue they collected.  So they raised and created taxes even more.  They peaked with an income tax of 77% on the wealthiest Americans.  And still revenue collected actually decreased.  It decreased because the wealth creators saw no value in the government's services.  They chose not to buy, or produce income that would only be taxed.  This led to a depression in 1920.  

Warren G. Harding became president in 1921 and one of his first and most important appointments went to Andrew Mellon as treasury secretary.  Mellon immediately proposed cuts to tax rates, especially Wilson's "excessive profit" taxes.  And like the Laffer Curve or retail pricing models show, revenues increased.  As Mellon said, "Any man of energy and initiative in this country can get what he wants out of life,” he wrote. “But when initiative is crippled by legislation or by a tax system which denies him the right to receive a reasonable share of his earnings, then he will no longer exert himself and the country will be deprived of the energy on which its continued greatness depends.”  

Seems pretty simple.  Who is going to work to their maximum capability when most of the rewards for their hard work is going to fund a federal government whose policies and practices they do not necessarily support?  As one scholar joked, "three presidents served under Mellon" during a prosperous time now celebrated as the "Roaring '20's." 

Here's a link to a history of income tax in the United States, that illustrates, albeit unintentionally, Laffer's Curve. Maybe our next president should have a business background, rather than a community organizing background.  Our present organizer-in-chief seems to have only learned economics from Dennis the Menace, and didn't even operate his own lemonade stand.