Wednesday, April 27, 2016

I Like It. I Don't $40 Like It. - A Primer On Prices

I've stated on these pages in the past that I have very little patience with those who decry "price gouging" in a market economy.  Competition and the flow of information to consumers in a Market Economy make "price gouging" virtually impossible.  Consumers will only part with their money when they value what the seller is offering more than they value to money they have in hand.

Early yesterday morning I dropped my wife off at the train station and made a quick, pre-workday run to the local Meijer for a bag of pool shock (having a nightmare this year keeping the chlorine level where I need it, but I digress) and to grab something to feed the four legged girls.  On the way from the pool section to the grocery aisles I stumbled upon these.  As you know, the Cubs are the real deal this season and I've been a long suffering fan for a decade now.

CUBS SWIM TRUNKS - I threw the brakes on.  HOW NICE ARE THOSE?

They are made from a very nice material, have the tie waste band, probably make that whooshing sound when you walk, which is great because it annoys my wife.  The logo is quality.  Man, are those nice.  How much?

What?  $40??  That's crazy, there is no way I'm paying that much for them.  So I hesitantly walked on after taking the picture.

What do you think the store manager would have said had I complained about the excessive price?  

He'd be courteous, of course, but as a corporate entity there is very little he could have done to meet me at a lower price.  In his inner monologue, he'd call me a kook.  

Do I like the Cubs trunks?  Of course.  However, I don't "$40 Like Them."  That's something that I often say when I see something that I like that I don't desire more than the cash I have in hand to get it.  As a consumer, that's my option.

Of course, there are other providers that can offer something similar at a better rate.  I'll be more likely at this juncture to pay $25 for something like this.

Now, I may walk by them a couple more times over the course of the coming weeks and change my mind (they are damn nice).  But for now, I value my $40 more than I value the trunks.  Again, they are nice, but not "$40 Nice."

I have some frothing-at-the-mouth Cub Fanboys as friends who would disagree and pay $40 or even more.  Why, because they value the Trunks more than the $40 in hand.  To them, they ARE "$40 Nice."  I'm not there yet.

So, what does all this have to do with my angst over the Gas Outters and other whining Price Gouging Fascists?  Because prices are an indication of where a competitive market is for a given product.  Put another way, as Don Boudreaux, Russ Roberts and Mike Munger often say on the EconTalk Podcasts (recommended highly, by the way), "Prices are merely signals that give feedback to producers."

It goes this way.  The producer of these trunks have a cost associated with producing them.  Like every entity in business, there needs to be a reward for the effort of producing them.  What is the value (put aside the financial suicide of the company if they did) of producing something and selling it for exactly what it costs?  The Cubs Swim Trunks Charity would fail miserably because it would be unsustainable.

But on the flip side, if the producer put $15 into making a pair of these things and tried to charge $150 for them, would they sell (just for the exercise, we'll forgo the markup that Meijer adds)?  If they did, that's a good racket to be in.  But a competitor entering the market is going to see this disparity and sell them for $35.  If the $150 provider has any business sense, he'll see that consumers don't value his product about their $150, and that his rival sees the disparity and is willing to take $20 profit over nothing.  So what does the $150 provider do, when he realizes his product is not "$150 good"?  He's going to get in line with the market.  He had better, or the $35 producer will take his customer-base off at the knees.  That is what economist talk of when they refer to "elasticity of demand."  Products like the $40 Cub Trunks have a VERY elastic demand as a general rule.  That is to say, demand for the product (ie, willing to pay a price for them) is very reactionary to price.  I don't need them "$40 bad".  The demand for them has a close tie to what they cost, and will fluctuate with a change in price.

By contrast, things like Insulin... and yes, Gasoline... will have a largely inelastic demand.  There are few viable substitutes for them so consumption will (mostly) remain constant even when prices rise.  However, two very important points.  First, inelasticity of demand doesn't mean that consumption will always be constant as prices increase for these goods.  The JAM PACKED trains of Metra in Summer of 2008 are a case in point here, as the price of gas was well over an agonizing $4/gallon.  It simply means that the consumption of products with inelastic demand will not vary as wildly as Cub Trunk consumption.  Second, and this is key: even within inelastic markets, there is still competition among providers to keep prices in check.  Witness the generic drug market or, the way gas stations sit right next to each other, changing prices in concert with one another in either direction.  They want to maximize profit to stay in business but the market - the station right next door - sets the rules.  I can charge $4 a gallon when the BP next door has it for $2.25... but I'm not going to sell a whole lot.  

One more thing on gas prices... scarcity makes market prices imperative.  Jeff's Golden Law of Markets: In a market where goods are in demand but limited in supply, SOMETHING has to ration.  Either the market (that is to say, the pricing system I describe above), or a corruptible authority (a government or government entity).  This is especially true in health care.  I could go see the doctor when I cut my finger slicing onions, but the expense of shelling out his premium is cost prohibitive, even with insurance.  So I use Neosporin and a BandAid.  But if the cost is free?  Everyone will want my Doctor's time (which is limited) and something of authority will have to ration, eventually.  Then who's politically connected?  Something tells me that Fortune 500 CEO's family will always have access to health care in that situation, but the struggling single mother will have almost no options because she's not politically connected.  When demand is tied exclusively to market prices, its manageable without weaselly Democrat Politicians brokering it for their own ends.  That's why, I'd rather let people ride Metra until the market returns sanity to the gas prices (which is tied largely to oil production).  Its better for everyone involved when they understand the system.

So I'll hang on to the $40 for now and use the worn out trunks with the hole in the crotch.  When my demand for Cubs shorts changes, I'll reconsider.  Not now.