Folk economics: setting prices

There may be some truth to the explanation classical economics offers about how prices are established in a free market, but the social role of that explanation is to make us as consumers feel better about the total mystery that a price represents to us. When we notice that the price of eggs has jumped by 30% from the last time we bought, we assume that there is a good reason—we have no knowledge that would lead us to that conclusion, but the law of supply and demand tells us that it is so. Or we pick up a Lunchable and wonder how five cents worth of food merits a $2.99 price tag—but even if we can’t figure out why it does, we know that it in fact does, because apparently people value the contents enough to pay the price being asked. And so we buy our eggs and Lunchables knowing that, even though we don’t understand the prices being charged, those prices have been established as fair. By the free market.

This is how a consumer society encourages consumers to think. Whether or not a producer thinks this way as well, he will find such thoughts to be absolutely no help when trying to set a price himself. As close as it comes to being helpful is when there is a “going price” in the area for a particular item. For example, we sell our eggs for $1/dozen, because everyone sells their eggs for $1/dozen, and it has been that way for a long time. This may look superficially like supply and demand at work, but it really isn’t. All the relevant inputs have varied widely over the years—feed costs, interest in locally grown produce, area incomes—but the price has stubbornly stayed at $1, judging from the fading paint on the homemade signs that pepper the roadsides. And we didn’t do any sophisticated calculations to figure out what our per-dozen price ought to be, aside from some back-of-the-envelope work that convinced us we wouldn’t be losing money at that price. The fact that there is a going price around here saved us a lot of thinking; either we were willing to sell for that price, or we weren’t. But the price itself was not established by the aggregate of a bunch of ongoing supply-and-demand negotiations. People decided awhile back that $1 was a fair price for a dozen eggs, and haven’t yet seen a need to revisit that decision.

Ed Sossen, host of a Christian radio talk show in Austin, once told how before coming to Austin he had a small side business involving calligraphy, mostly hand addressing wedding invitations. It was profitable, but his other activities were more profitable. Eventually he decided to get out of the calligraphy business, but instead of just shutting it down (and having to explain that decision to old customers) he decided to instead discourage business by raising his rates dramatically. But instead of scaring off customers, he found that his business increased dramatically. That was enough to keep him at it for awhile, but soon enough he wanted to put an end to it, so again he raised rates dramatically. And experienced another dramatic increase in business. At which point he simply shut down the business.

This echoes the story that Tom Wolfe tells about Marshall McLuhan, who was just becoming known as a media guru:

The phone rings in Gossage’s suite and it’s for McLuhan. It is a man from one of America’s largest packing corporations. They want to fly McLuhan to their home office to deliver a series of three talks, one a day, to their top management group. How much would he charge? McLuhan puts his hand over the receiver and explains the situation to Gossage.

“How much should I charge?”

“What do you usually get for a lecture?” says Gossage.

“Five hundred dollars.”

“Tell him a hundred thousand.”

McLuhan looks appalled.

“Oh, all right,” says Gossage. “Tell him fifty thousand.”

McLuhan hesitates, then turns back to the telephone: “Fifty thousand.”

Now the man on the phone is appalled. That is somewhat outside the fee structure we generally project, Professor McLuhan. They all call him Professor or Doctor. We don’t expect you to prepare any new material especially for us, you understand, and it will only be three talks—

“Oh—well, then,” says McLuhan, “twenty-five thousand.”

Great sigh of relief. Well! That is more within our potential structure projection, Professor McLuhan, and we look forward to seeing you!

Here’s a similar tale, taken from the home business column in Countryside magazine (Sept/Oct 2006). (The writer makes wooden tankards to sell at renaissance faires.)

One time, in a silly mood, we made something we called a ‘barrel purse.; It was literally two wooden half-circle barrel halves hinged together and hung with a leather strap. It weighed around ten pounds. If you wanted to access the inside and weren’t holding it right, it slapped open and dropped all the contents on the floor. It was stupid, silly, absurd, and we priced it at something like $5 and kept it as a gimmicky thing. We toted that barrel purse to no less than ten different shows over a period of six months and hung it from a center pole of our booth so no one could miss it. Of course, it never sold. Who would buy something so stupid?

Then one day at a show, in a moment of levity, we added a zero to the price tag so that it read $50 rather than $5. We sold it within half an hour.

Don’t get me wrong—we told the customer everything that was wrong with it. It didn’t matter—she loved it, had no qualms about paying the price, and walked out ten pounds heavier and $50 lighter. My husband and I couldn’t believe it. […]

Many years ago, in another moment of levity (we have a lot of those), we took an ordinary tankard, cut it up at funny angles, twisted the pieces around, and glued it back together. The result was a crooked tankard that looked drunk. We put it on display at a show for a ridiculously low price, something like $5. People mostly ignored it.

Then we put it on prominent display and upped the price to $45. Within minutes we had two people literally arguing over who would buy it. We settled the argument by promising one of the customers that we would make him another one just like it, which we did. We have made crooked tankards ever since, and they have become one of our best sellers.

During holiday car rides one of the moments I enjoy comes when ads for particular sorts of gifts come on the radio. The kids are usually baffled at the idea that someone would pay, say, $80 to Vermont Teddy Bears to have them deliver a $3 stuffed toy to a wife or girlfriend at her place of business, especially when they hear the toys described. I point out to them that what is important in the transaction is not whether it was worth $80 to have that $3 toy delivered, but that the gift-giver was willing to fork over $80, and that the recipient (and her friends, I suppose) are well aware that the gesture cost $80.

But my favorite all-time holiday gift radio commercial is for the International Star Registry, who for $54.95 will name a star after a loved one. These folks have been around for at least twenty years, and it is well known that they are no more authorized to name stars after people than any random person. They “register” these star names by printing them up in a booklet and sending them to the U.S. Copyright Office, just like you are free to do with any book you write yourself. But despite the fact that they provide absolutely no service at all, they still find enough customers at $54.95 to make it worth their while to blanket the holiday airwaves with costly national radio commercials.

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8 thoughts on “Folk economics: setting prices

  1. Way back in the early 70s when my daddy started his chemical analysis and consultation business, he charged something like $5 an hour for consultations. He didn’t pick any new business so he upped his fee to $35/hr and business took off.

    Maybe this is people thinking “you get what you pay for”? Since that’s a generally true concept people assume it’s always true and works in reverse too…?

  2. I have become convinced that prices often have little to do with the free market at all. Sometimes it’s like you said, what everybody else does, so everybody sells at the same price. No one knows why. Sometimes it’s just what the heck, I’ll charge this much. Insurance for example. If you price insurance you will often find that all the companies charge approximately the same for the same coverage. As if there wasn’t really much competition actually happening. . I have my suspicions….. anyway, I think economists know less about how people make economic decisions, than they think they do.

  3. I’m going to have my wife read this. She is fretting over raising the price of her homemade breads at the farm market this year. The dollar a dozen barrier for roadside eggs seems to have been broken here in the past couple of years. $1.50 is common. As for me, after reading this, I’m tripling the prices on all my Whizbang books!
    ;-)

  4. Farmers’ market eggs in Manhattan go for $3.25-$4, depending on the size and vendor. I’m curious as to what they sell them for upstate (obviously these farmers don’t live in Manhattan). But the item that really puzzles me is stewing hens. I like them because I make my own broth for soup. I bought several for $4 apiece last spring. Now a different vendor is selling them for $8. (At least this one had feet, which release their cartilage quickly.) I bought, because there’s usually only one chicken vendor selling at a time, it’s an item not available in stores, and even $8 stewing hens are still about half the price of broilers. I would have asked out of curiosity, but the woman selling didn’t speak much English, and it was cold out. So I chalked it up to the weather, and went home with my hen.

    I’ve had the same experience with my portraits. I won’t go into the details, but higher prices seem to give the client confidence that he/she’s getting a more valuable work of art. The phenomenon is even more pronounced at at museum levels. Painters go in and out of fashion, and the prices reflect the change by factors of ten…and sometimes much more. For the same painting.

  5. I just don’t understand the whole pricing thing at all. When we started selling soap we wanted the price to fair. It doesn’t cost very much at all to make and we thought the going price was a little too much. People complained that we were not charging enough, some people even paid us more than we asked. Many say that we’d sell more if we raised the price.

    Did you see a drop in sales when you lowered your book prices, Rick? Something tells me books would be an exception to the “higher the price the more you sell” theory.

  6. I’ve had a couple occasions in which folks paid me more for a project than I asked. I’ve never been able to get a good handle on pricing either. I like to work with wood and I hope I can always give folks a good product for the price. As for me, my aspiration as far as money goes is to be able to pay my bills and occasionally enjoy the fruits of my labor.

    Regarding the sale of eggs, I live far enough north that our hens are not able to find anything outside besides ice and snow. I like to feed them an organic mixture of various grains grown by a friend of mine, but I have to pay a $3 a bag premium for it over the ground up egg layer feed . I figured out based upon our recent egg production that I have about $4.50 in feed per dozen. I guess we’ll ignore the electricity for the light and the electric heater to keep the water from freezing. I sold some eggs last week for $1.50!
    When we first started have a surplus of eggs, an elderly neighbor came down and handed us $.75 for a dozen. I never even gave her a price and to be honest, I would have been happy to give her some. A couple weeks later she came back and told us she owed us more for the eggs because they were getting much bigger. She handed me another dime!

  7. This might not be the perfect post to put this link under but it is relevant to the discussion of many posts!

    The latest EconTalk is interesting. Some discussion about the Amish among other things.

    http://www.econtalk.org/archives/2008/03/marglin_on_mark.html

    “Stephen Marglin of Harvard University and author of The Dismal Science: How Thinking Like an Economist Undermines Community talks with EconTalk host Russ Roberts about the markets and community. Marglin argues that markets and commercial transactions undermine the connections between us. He wants people to pay more attention to what is lost and not just what is gained by the pursuit of material well-being. Topics discussed include the nature of community, the role that voluntary associations play in our lives, the costs and benefits of mobility, the role of insurance in reducing our dependence on each other, and the nature of knowledge.”

  8. Thanks for the link, Ethan — it seems like it would be a good thing to listen to with my older children during our regular afternoon discussions.

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