How much is a burger? I don't care. I am willing to pay $5 for it. Priced any lower or equal, I buy. Higher, I don't.
Will you believe me if I tell you that everything can be priced? And by everything, I really mean EVERYTHING. Book, car, boat, education, the moon... none can be described as "priceless". It is the exact opposite to the more safe and pleasant philosophical teaching about how certain things like love and life are invaluable. Yes, you read it right. Love and life can be priced. You'll see why. Just keep reading.
And, contrary to some popular beliefs that the rise or fall in price is related to rise and fall in greed or perverse desire to reap benefits or steal from people, economics views price as the pivot of an economy. Price is both objective and subjective (kinda more subjective, to be frank), and in a free market economy, price corresponds to the law of demand and supply. Roughly speaking, price involves cost, desire, and at the moment of transaction, price equates the values between two or more exchanged goods or services.
So, to reiterate, there are four factors (Yes, not three. I know. How random.) that altogether determine price:
- Cost (of production):
The amount of tangible and intangible resources used as inputs.
(Just a side note: That is why we have something called cost-push inflation.)
Occuring outside of the production chain, desire takes into account of the want and need of goods or services offered or not-yet available, which ultimately leads to compeition among consumers.
(Another side note: That is why we have something called demand-pull inflation)
- Equalization of values:
This is a bit tricky. Let me illustrate the concept via an example. For example, a merchant might be willing to sell you an apple for $1, but at the same time, the merchant does not just accept money. If he/she loves orange and if oranges sells as well as apple, he/she might also be willing to trade an apple for an orange. In this case, 1 apple = 1 orange = $1. Of course, if for some reason, orange plantations across the globe are found to be afflicted by land contamination deteriorating their quality, then there is no doubt that the merchant will definitely turn down any orange-apple deal or raise the quantity of orange to astronomical ratio, probably something like 100:1. In essence, price is derived from the equalization of values between things offered to be traded, and unless equalization happens first, transaction is not possible (unless, you do it at gunpoint... which is bad and warrants your stay in jail).
- External factor/shock:
Like the above example which shows how the perception of quality can mess up orange price, external factors/shocks (I prefer it be called external shock) are all the unaccounted, unexpected, and mostly uncontrollable factors that can either directly or indirectly affect the movement of price. They range from something as petty as a fly in your soup to World War III (...which will hihgly likely be skipped because the future war is so going to be intense, it will skip all the 3 and 4 and 5 and jump to World War Z. Ha!)
These are the four factors I can think of. Well, people make mistake. I am one of you people, so I do make mistake(sss) from time to time, and of course my friend, rather than asking for forgiveness, I am asking you to let me know if you can find something even more exciting to add to the list. Anyway, I guess there is one more to consider. Though technically, it cannot considered as the 5th factor, it is just as important as the previous 4. There is one thing left you need to look into, which is:
All the Correlations between the 4 factors:
Of course, these 4 factors are strongly correlated. One leads to another. For instance, if people want more fresh potatoes, then potatoes price will increase. Consequently, your beloved potato chips will also increase in price because it now costs more to purchase the primary input, potatoes. Thus, stronger desire for something may lead to rise in cost of production for something else. Every little change can have either a huge single impact or an equally huge impact as a result of aggregating smaller impacts on various places or layers within a system. Well, I hope the next part of the article will help clarify my point.
With these in mind, let's proceed to the next level. We will look into an example that will demonstrate the role that each factor plays in the production of goods and services. Let's look into the fast food industry, and burger, i choose you.
Since I don't run a restaurant, I really have not much idea of how things work. But, unprofessional as I am, I will try my best to run a simulation of a burger restaurant. Remember though, the star of this example is the burger, not the restaurant or the fast-food business. Simply put, I am trying to explain to you the economics of pricing, using the 5 points above to answer a simple question: Why a burger is priced at, say, $5?
First, we need to dissect the entire process of getting a burger to your mouth into several different stages from the very beginning to the very end.
To understand the origin of a burger's price, we must first understand the origin of the burger itself. Again, I might unknowingly miss lots of steps or just describe it plain wrong, but do note that, I am trying to simplify things as much as I could without hurting my brain.
I honestly don't believe that french fries is one of the ingredients for making burger. Why is it even there?Whatever.
1. Cost of Ingredients:
- Meat (beef, pork, chicken, etc):
It costs money to raise livestock because livestock needs food, land, water, healthcare, etc., all of which requires natural resources, labour, time, machinery, energy and others that cost money. Let's say, it costs $0.5 to get a piece of ground meat.
- Veggies (carbage, tomato, cucumber, etc):
Like meat, cultivating and harvesting veggies cost money. Fertile land, water (lots of water), fertilizer, favorable geographical location (with the right amount of precipitation and weather conditions in general), pesticide, and a huge amount of miracle (kidding). These need human labour and time. Let's say, to get all the necessitites done, it costs $0.5 (to get all the veggie for a burger).
- Processed ingredients:
You don't simply carve a cow and put the whole meat into your burger. Likewise, what is a burger without pickle? So, you see, there are processes involved to turn beef into ground beef and cucumber into pickle. You need to hire people to do that. You need to build factories. You need machineries (talking mass production here). You need research and development. You need inspection on quality to make sure the outputs are suitable for human consumption. All these cost money. Let's say, it costs another $0.5/burger to get all the processed stuffs done.
- Buns (It's bread, but prettier):
What do you call a burger without buns wrapping around the meat and veggies? Anything but a burger. You need buns, of course, and to make them, you need flour, yeast, salt, oil, heat, etc., and all the required processes to make it nice and round (and edible). Before that, you need to grow wheat... and even at this early stage, we can see all the cost revolving around the agricultural production of wheat appears. Don't forget the yeast, the salt, the oil, the heat... they cost something to make. Let's say it costs another $0.5 to make a bun.
2. Cost of transporting ingredients:
Even teleportation might cost something, but since this technology is not available YET, we need to rely on the conventional land, water, and air transportations. It definitely costs money (to get gasoline, to maintenance, etc) to get the wheels moving. Ship doesn't have wheels, but I guess we are grown up enough to not having to argue about that.
Transportation costs happen at all stages, starting from taking cows to slaughter house to getting cucumber to pickle-making factory to getting all the meat, veggies, salt, pepper, and buns to the burger restaurant. Let's say spreading the whole tranporation cost into cost per burger, we find it to be $0.5/unit.
3. Cost of making burgers and running the burger restaurant:
Now, all the ingredients end up in the restaurant. What now? It's time to make a burger. But to do that, we need a chef, a few assistants, a manager, waiters, cashiers, etc. Not to mention, we kinda need an actual restaurant, a building I meant. We lease and renovate the building, hire the people, get the essential cookware, and so forth. These steps and stages cost money, again. Let's say, dividing the total cost into all the expected number of burgers sold, we end up with another $0.5 cost per burger. This, of course, has to take into account of the daily cost of running the business, which also includes the cost of utilities.
Assuming this wraps up all the cost of making a burger. It amounts to $3. But wait, the burger is priced at $5, doesn't it? So, what accounts for the other $2? Just pure profit or what?
4. Consumer demand (Demand/Want/Need):
Let's say, you make the best burger in town. People flock to your restaurant just to get a taste of that juicy beef burger you make. Good for you. It's a smooth sailing. However, this relentless number of people coming into your restaurant likely translates into "low demand elasticity". Lower demand elasticity simply means that people are much less likely to stop buying from you if the price of your restaurant's burger goes up. In other words, people won't stop buying the burgers even if you raise its price a bit higher. People compete for your burger, so they are bidding up the price; they are willing to pay more to get the burger they crave for. This means you are able to raise price to gain more profit.
Even if you are not a profit-hungry wolf, this constant crowd is equivalent to higher cost of maintaining the quality of your burger and your service. Eventually, it also means expansion. As you have more branches, you will have to order much more ingredients. Your large order means higher demand for meat, veggies, and buns; thus, taking them away from other businesses. The greater the amount of ingredients you demand, the more you have to pay to get them. Remember, just like how your customers compete for your burgers, you are competing with other business owners (not limited to fast-food industry) for the ingredients. This will force you to drive price up, whether you want it or not. And as long as the demand is strong, people will give you an okay sign for your higher price.
Note: The fact that the restaurant can influence price is based on the assumption that the burger restaurant is able to differentiate itself from the rest of its competitors allowing it to free itself from the strong competition current.
5. World War Z (External Factor):
Let's say World War Z happens, and all the town folks have been turned into zombies. Zombies like brain, not burger. So, this will hurts your business, forcing you to drive your price down and suffer from lower profit, or in the worst case scenario, close down your business.
6. Burger cures Zombieness (External Factor)
All of a sudden, the latest medical research found the cure for zombies, and that happens to be burgers. Governments from all countries, from east to west, order all the burgers they can get their hands on. Your restaurant suddenly opens up for business again. Operating at full speed, you make all the burgers you can with each priced at $100. Expensive? Yes. Why? Because this tremendous demand creates a situation where more cows, more veggies, more buns, more processing, more labour, more energy are needed. This much demand will definitely exhaust all the currently available resources while operating at full capacity. This leads to shortage and bids up the price. Profit realized, the industry expands, more research and development funded. Plus, burger is the only cure. All these lead to higher per unit cost of burgers. So, it is not a surprise that a burger costs $100 at this point.
7. Inflation (Equalization of Value)
This is also an external factor, but I want you to focus on the equalization of value part. Let's say that the zombie apocalypse results in less place accepting money as a medium of exchange. Money is everywhere, but food is scarce. This causes money to depreciate in value. As a result, it now costs much more to even get an apple. Since people are less willing to take money, you might need to offer $50 even for an apple, to convince the seller to trade with you. This is problematic because if an apple is priced at $50, then a burger cannot be priced at $100 (i.e. 2 apples), can it? Following this rationale, burger price might rise up to $500 per burger. No kidding!
8. Everything is connected
Keep in mind that price of one good can affect many others, and that price can fluctuate as a result of many different variables, though some are less obvious.
For example, during summer, people are more active outdoor. They travel more. This creates greater demand for the use of vehicle, and thus, gasoline. It pushes the gas price up, and all else constant, the cost of transportation will rise. In other words, it means the cost of getting all the ingredients to your restaurant increases, and thus, inevitably, you will find yourself in a situation where you need to pass on at least a small portion of the increased expense to your customers in the form of higher burger price. So, something as crazy as warmer temperature increases burger price is possible.
All of these sound like a joke, but it presents to you a scenario that makes sense of price. People tend to associate rising or falling price with the rise in cost of production or the greed of producers. The "cost of production" is spot on, but in free market, greed is least or not effective at all. Demand arises at various levels can shape price, so can the inherent need to equalize value for transaction to settle.
You might notice that price, while seemingly objective, is subjective in nature. While the cost of ingredients and transportation of ingredients constitute a burger's price and are factored in objectively using simple maths, the subjectiveness lying within people's perception of burger, their wants/desires and willingness to pay a certain amount for a burger also play an equally important role in determine the final price.
And think of it this way. Although a burger costs $5, the fact that you are willing to pay for it means that you view your consumption of burger as something that gives you higher satisfaction than a $5 bill could give you. If you are willing to pay up to $8 for a $5 burger, you will have $3 happiness.This is your consumer surplus, to be precise. Producers as well, sellers as well, view the $5 price as a profitable mark. In other words, they are willing to sell you a burger for $5 because their calculation shows that $5 is more valuable than a burger. This turns into profit that allows them to continue doing business. If transaction is objective, that means you are exchanging your $5 cash with something that is worth exactly $5 to you. What is the point? Won't it all cancel out and the whole thing becomes a zero-sum game? Won't you gain nothing from the transaction but the trouble you cause yourself simply by walking to the restaurant and spending time waiting in line? You might argue that it is for survival or because people simply need to eat. But I ask you, how about buying other stuffs like bracelet, chair, car, laptop, ipad, and many others?
A simple way to wrap your head around this is to look at the real-life scenes that play out every single day. Have you ever argued with friends or heard people argued about whether or not something is worth its price? Is this or that particular brand of laptop worth the $1,000 they are charging you? You might say yes; you might even be willing to pay more for it, and there are people who would even fight over it when the laptop is the last one in stock. At the same time, there are people who think that the laptop is overpriced, that they would only pay $800 for it. There are even those who wouldn't buy it even with %50 discount! You see, price is subjective because people are the one who assign value to the millions of different things they come across in life.
For the same reason, love and life can be priced... maybe not by you, but by someone else. Let's say an evil being view your love as somehow annoying to him. He wants you and your girlfriend to break up. If he is willing to pay up to $1000 (and no more than that) to break you two up, then stupid as it may sound, $1000 is the price of your love to the evil man. Since the final conclusion is that price is also inherently subjective, this subjectiveness becomes one of the premises in explain and understanding price all things. Remember, it is a truism that subjectiveness is all about personal taste, personal opinion. Since opinions vary from person to person, everything can be priced. In other words, whatever is priceless to you might be worthless or not-so-priceless to somebody else.
There have been attempts to measure the price of life by many... individuals and organizations alike. For instance, I have heard of a research that assigned monetary value to a person based on the estimated aggregate worth of goods, services and social well-being that he/she can contribute to his/her society over the course of his/her lifetime. This is logical, though unethical, and they did arrive at price for certain individuals. Also, things as simple as wage is actually the price of your labour, which is derived from your lifeforce, pretty much your life.
You see, price is at first glance simple and boring. However, economics makes it much more interesting, just like how Discovery Channel films a boring factory and make all of you watch it so attentively. Great stuff anyway. I hope you enjoy the article, and I will see you again in another article!