What can an entrepreneur’s attempt to profitably ship ice from America to the Bahamas teach us about economics? We’ll see, but let’s begin with some fundamentals.
Prices, property rights, and profit (and loss) lead to information, incentives, and innovation. This simple statement contains nearly every lesson necessary for a free and prosperous society. But what do these words mean?
Prices convey information about relative scarcities and communicate to us the relative value of competing uses of a resource. They also economize on the acquisition of knowledge. When we see the price of a resource rise, market actors understand the need to use less of the resource. What they don’t know, however, is whether this rise is due to a disaster that destroyed some of the stock of that resource (an inward supply shift) or if a new, more valuable use for that resource has been discovered (an outward demand shift). These facts are irrelevant for a person who is currently using the resource, but from a societal level, her using less is necessary. If there is a disaster, we would want people to use less of it so that everyone else can still use some. If there is a new, more valuable use discovered, we would want the original users to use less so that more could be allocated toward this new use.
The term property rights refers not only to the right to use a resource but also to the right to exclude others from its use. In this sense property rights provide the incentive to allocate the use of a resource efficiently across time, for example, to conserve it for later. With firmly established and enforced property rights, not only does the owner not have to worry about someone else taking his things, but he also doesn’t have to rush out to gather the resources as quickly as he can. A situation where there are no property rights is susceptible to what is called the “tragedy of the commons,” where the resource gets depleted too quickly and never has a chance to replenish.
Profit (and loss) leads to innovation. Earning a profit is akin to being rewarded for doing something good. Suffering a loss is the opposite, a penalty for doing something wrong. In this case the deed being done is the attempt to allocate scarce resources to where they will earn their highest return. People who successfully do this are rewarded with monetary gain, which we call “profit.” People who fail to do this experience what we call “loss.” In attempting to allocate resources efficiently economic actors learn what works and what does not. Reducing the profitability of an activity through taxes or legislation, or sheltering people from losses, therefore retards this learning process and stifles innovation.
Ice and Price
This lesson is exemplified in early nineteenth-century Boston with the rise of the American natural ice trade. In 1806 Frederic Tudor sailed a ship full of ice from Boston to the Bahamas. Two years earlier Tudor had begun experimenting with insulation with the goal of bringing ice to the Bahamas. When he was ready to set sail, he found that the ship captains refused to carry his cargo for fear of damaging their vessels. So he bought his own brig, the Favorite, and set sail February 10, 1806. He arrived in Martinique with a large quantity of ice still intact and began selling. The Bahamians loved the ice, which they had never seen before. Yet that first year Tudor lost a substantial sum of money, although he proved that ice could be shipped to the Bahamas. Now the objective became to do it at a profit. Convinced his idea would be wildly successful, he continued his attempts to drive down costs and increase demand.
Meanwhile, as the price of ice on the ponds rose, the people of Boston gained the information that it would bring a higher return in the Bahamas, thus they used less themselves and sold the ice to the Bahamians. The price system reduced consumption and increased production through competition. In 1840 the ponds in the Boston area were explicitly divided, giving each person on the lake the right to exclude everyone else from harvesting any ice that wasn’t his. This allowed Tudor, for example, to invest in his ice and let it freeze longer so that it could better survive the long journey from Boston to India, which entailed crossing the equator twice and sailing around the tip of Africa. As Tudor earned profit from his venture, more people were attracted to the ice.
To continue to earn a profit, therefore, he had to find a way to outcompete everyone else. In 1825 Tudor enlisted the help of Nathaniel Wyeth, one of his suppliers. Tudor noticed that Wyeth’s ice was always significantly cheaper than everyone else’s and was cut in neater blocks, which packed more easily. Wyeth had converted some old farm plows into ice-cutting plows and had fastened horseshoes with spikes to allow horses to pull these modified plows across the ice. By scoring the ice in such a fashion, Wyeth could break uniform-sized blocks much quicker than his competitors, who were using hand saws that produced rough and uneven edges.
These wouldn’t be the only contributions of Wyeth, as he went on to invent many other cost-saving techniques. For example, Wyeth developed a conveyor-belt system that would haul the ice from the pond into the waiting icehouse. He also invented bigger plows that could cut more blocks at once and poles that were used to guide the floating ice blocks onto the conveyor belt, and refined the above-ground icehouse, which allowed ice to be stored anywhere in the world for months on end without any external source of refrigeration.
Tudor and Wyeth also experimented with new means of insulating the ice from the heat, discovering that sawdust was not only a fantastic insulator but was also cheaply available from the sawmills around Boston. They also taught their customers new ways to use the ice, including making ice cream and storing the ice in iceboxes to preserve foods longer.
In short the three Ps lead to the three Is: Prices, property rights, and profit (and loss) lead to information, incentives, and innovation. With these firmly in place, a free and prosperous society will follow.
David Hebert is a Ph.D. Fellow at the Mercatus Center at George Mason University.
Copyright © 2012 Foundation for Economic Education. All rights reserved. Used with the permission