Here is a small conversation between me and a friend of mine on derivation of price.
H to A:
Price determination is primarily based upon:
- How much the customer is willing to pay (Value)
- How much the optimization will save customer, which in turn boils down to how much customer is willing to pay (Value)
- Adding the profit margin on top of the real cost (Cost)
Between Value and Cost, I feel that if things were Cost based, those will be more logical than emotional and would reduce the financial mess today to a great extent. This is a very primitive 5-minute though that occurred to me. What do you think?
A to H:
I don't know if there is any specific perspective to this discussion/idea. But my best guess is this is a random thought.
You are right - about value and cost. Price is (generally, but not always) in between these two extremes.
I tend to incline towards your thinking that cost-based pricing (as against value-based) will produce less trouble - but I don't entirely agree with it. Two reasons:
a. value based is not illogical. The cost of a plate of vada-paav is probably 1.5 Rs, even with decent margin of say 100% profit, vendor may price it at 3 Rs. But if it's only one vada pav in market, and two hungry people - howz vendor going to choose whom to sell? The only answer apart from 'checking who is more hungry' is first come first serve. But that seems more illogical than value based. The more hungry is most likely to have more value and most likely pay more.
b. The cost and value based discussion about price is not complete in itself. Demand and Supply play a very crucial role. This is rational economic discussion. Some of the goods - at certain time period - are in excess supply or short supply. Onions when we were in college touched 40rs/kg. Cost was definitely not more than a single digit number. Value- again I never felt it gave me more value to eat a 40 rs kg onion. But the demand was normal, while supply was almost vanished - price ballooned.
H to A:
Yeah, this was random.
On Value, picking the Vada Pao example, it may not be necessary that the person who is hungrier will end up paying more. A poor person also has the right to be hungry. People pay more because there are no other options.
At first thought, First come first serve sounds better than inflation of price based on demand, at least the person who came first planned for it and reflects the need. It may not be the best solution though.
Price inflation based on demand is a way of giving privileges to the rich, who in turn may have grown rich with same fundamentals of price inflation based on demand. If there were better way to measure the “need” as opposed to someone’s ability to pay higher, the society would be a different.
The basis for paying higher than cost+profit comes from different kind of emotions:
- I want to possess what is rare and I’ll pay whatever it takes
- I want to have it before someone else
- I should be the first one to get it
There is nothing wrong in having such emotions, we all have it and hence we do pay inflated prices. The price inflation model I believe works well with the so called “tamasik” aspect of a human being, which is pretty dominant in this “Yug”.
