How Do Busines's Decide What to Sell an Item For?

[Martini_Enfield]

@GuanoLad

If I could, I would sell it for what I think it’s worth. But realistically, I would have to recover the cost of buying it originally, and take into account the cost of the new house I was buying.

I just think (unfortunately it appears foolishly and unrealistically) that house prices in particular should not be skyrocketing out of control, and ought to remain within the realms of general affordability, based on the cost of building it, maintaining it, and inflation, rather than as an “investment” I can gouge from potential unwitting saps.

I might add, by way of clarification for our overseas readers, that Australia (and, I’m told, New Zealand) are experiencing a Housing Affordability Crisis- the price of houses has just rocketed out of all proportion (and affordability), and in Queensland the average house price for anywhere you’d actually want to live is now pushing AUD$500,000 (c. USD$425,000 by way of comparison, for those of you who think we have Monopoly money for currency here).

Like GuanoLad I’d like to see houses priced as somewhere to live and not as an “investment.” Part of me would also like to see a cap placed on the number of “investment properties” people can own (one, perhaps, although I realise such an idea would be unpopular and unworkable).

At any rate, something needs to be done to ensure more people are able to afford a house in a liveable area. Sure, you can get a house and several acres for $30k. In the middle of the Outback, where you have to get your water from tanks, there’s no local work, and it’s an all-day drive to the nearest supermarket.

[RickJay]

@InvisibleWombat

With electronics, prices go down over time for several reasons:

1. R&D is paid off. If I spend $10 million on research and development to create a new gizmo, and I figure on selling 100,000 of them per year, I’m going to make sure there’s an extra hundred bucks in my selling price (wholesale, that is), to recover that ten million. After a year, I can drop the price.

That doesn’t make any sense, you realize. Why would you drop the price? The only reason to drop the price is if demand for your product is down (which itself can be the result of a thousand factors or more - saturation, price discrimination, market differences, technology, and many more) or marginal costs (R&D isn’t a marginal cost) goes down. If those things aren’t true, you either were charging too much before or you’re giving money away by dropping your price.

The price of electroncis goes down wholly because of the other things you point out, which amounts to “they’re cheaper to make now, and everyone’s got better stuff.”

That said, Shagnasty hits the nail on the head; price setting can be a wildly complex process that often goes into issues beyond the marginal profit made on the good being sold.

[Dewey_Finn]

@RickJay

That doesn’t make any sense, you realize. Why would you drop the price? The only reason to drop the price is if demand for your product is down (which itself can be the result of a thousand factors or more - saturation, price discrimination, market differences, technology, and many more) or marginal costs (R&D isn’t a marginal cost) goes down. If those things aren’t true, you either were charging too much before or you’re giving money away by dropping your price.

A lot of consumer electronics devices are priced high initially and sell only to the early adopters, who are willing to pay a lot to have the latest technology. But the majority of us aren’t willing to pay that much. So after a while the price drops, and sales increase.

For example, a VCR, DVD player or video game system might have sold for about $500 or more initially. Later the price of many of these things dropped to around $200, which is, I understand, the sweet spot for such things to sell widely.

[Rumor_Watkins]

@Dewey_Finn

A lot of consumer electronics devices are priced high initially and sell only to the early adopters, who are willing to pay a lot to have the latest technology. But the majority of us aren’t willing to pay that much. So after a while the price drops, and sales increase.

For example, a VCR, DVD player or video game system might have sold for about $500 or more initially. Later the price of many of these things dropped to around $200, which is, I understand, the sweet spot for such things to sell widely.

Isn’t that exactly what **RickJay **just said? They drop the price because at the current price, the demand has been filled, and there are no more “demanders”, so they decrease cost to meet the next group of consumers.

[CookingWithGas]

The article linked by **Walton Firm **is a good introduction. I have taken an economics course at the undergrad level and one at the grad level, and I have a whole book just on pricing theory. And I still don’t understand a lot about how it works in practice.

But the theory is that there is a curve that describes the unit price that a seller is willing to sell vs. the quantity sold (suppy curve), and a similar curve for the buyer (demand curve). Where supply and demand cross defines the price (more or less) where it will actually be sold in the market. The price is not determined directly by adding some percent profit on top of the cost to build it. In fact, a theorist will tell you that the cost of making a product has absolutely no relationship to what it will actually be sold for in a free market.

However, many types of products tend to have certain predictable patterns that fall out of this based on how businesses compete. Sellers of commodities, which are things considered by the buyer to be pretty much the same no matter who is selling it, tend to compete on price. This has become true of much consumer electronics. If someone is looking at three 46" 1080p LCD TV’s, they are generally going to buy the one with the lowest price. However, most sellers try to discriminate their products from others so that you can’t make such a direct comparison. Once sellers start to compete on price, they are in a “race to the bottom” with a low profit margin and have to increase profit by increasing volume. Whole Foods is very successful at posturing themselves as a premium grocer with better product and better service, and are able to sell at higher prices. However, in my area, Giant and Safeway compete on price. Although a Honda Accord and a Toyota Camry are in the same class, the companies try to emphasize the difference in their products, and most people think there is some difference, so that you would be willing to pay a little more to get the unique features they offer, whether it is extra cup holders, reliability, or better service at the dealership.

Another factor that allows a business to maximize profit is price elasticity. Price elasticity is the percent change in price divided by the percent change in sales volume. A product with high elasticity means you can’t raise the price without a dropoff in sales. Cigarettes are the textbook example of low elasticity products–you can raise the price quite a bit without affecting sales much, although an individual manufacturer won’t do it because of competition. (However, the government is very aware of this and that’s why cigarettes are such a big target for taxes.) Mid-luxury products tend to be more elastic. The really high-end items are bought by people who don’t care how much they cost, and the low-end items are bought by people who don’t have many alternatives.

If you can price your product at the point of zero elasticity, you are most likely maximizing your profit. That is, if an increase in price drops volume as much as the same decrease in price would increase volume, then you are at zero elasticity.

This is slightly oversimplified but one important thing is that this discussion applies to the market as a whole and not necessarily to a single buyer or seller. That is, the price I will pay at Best Buy for a set of headphones is not my personal demand curve crossing the Best Buy supply curve. I will either pay the prevailing market price, or not buy it.