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Monday, February 07, 2005

What is the connection between price and cost?

Very tenuous. In most circumstances, the lowest price will drop is the cost of production. However, we know that it does not cost $75,000 to make a Mercedes-Benz, so something else must be going on.

Economists have long debated the source of price, or value to the consumer, and still confusion reigns supreme amongst most people. This little ditty showed up in today's email box:
Most books being sold in used book stores are selling for less than the cost of publishing them.

Okay, but while it is dangerous to compare the price and cost of a single good in a single market, it is impossible to compare the price in one market with the cost of production in another market. It is entirely possible that those who purchase used books value the books at less than the cost of production of a new book. But this is the same as saying that those who purchase used cars value the cars less than the cost of production. The problem with this statement is that comparing the price of a used book (market A) with the cost of production of a new book (market B) is incorrect.

Obviously, it is difficult to produce a used book without producing a new book. However, the used book's cost is more accurately measured as the price that the used book store paid for the book, not what the publisher paid to produce the new book.

This is also an example of intertemporal price discrimination. Those who purchase new books value those books more than the people who purchase used books. If the only people in the market for books valued books at the used-book price, then the publishing market would have a serious problem on its hands. Lucky for those who place a high value on new books, the publishers are willing to produce new books. Lucky, too, for those who only value books at the used-book price, there are not only publishers of new books but people who value those books to buy them new.

A little appreciated aspect of the market process is the intertemporal price discrimination. When I got lasik surgery, I paid $1,800 per eye, four years ago. Today, the price is much less. But when my mom-in-law got the surgery it was $2,200 per eye. Same thing goes with plasma televisions, computers, and cars. The rich, those evil capitalist-pig dogs, buy expensive toys that eventually become the norm for the every-day Joe. My 1988 MB has airbags, crumple zones, collapsing steering column, ABS, and lots of other things that are standard on today's KIA.

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