Cost based pricing vs. Value based pricing – How naive are you about economic justice?

I believe the heart of the misunderstandings about economic justice and fairness is a misunderstanding about what a price is. Many people on all sides of the political spectrum have passionate views about economic justice and what this represents? It determines who to vote for and how the economy should develop. The central question is what is a fair price? And this includes the price of you are paid at work or your wage.

cost based pricing value based price
Cost of construction is almost the same for homes on the beach in contrast to a few miles away in the country but the price is several times more. People put up little cheap houses on the beach and yet demand a great price. This is because of the subjective theory of value.

Example of how naive people are with economics

There is a real estate agent in my office who sells high-end homes on the side. I am looking to buy a home and said I would work with her if she goes for the best possible price. Her reply was “I do not want to insult the seller by offering too low a price”. I was surprised at such a naive answer.

I questioned her as to why she has such a view. She explained how foreigners were coming in and low balling the prices and driving them down. She continues to explain that the price was a function of the cost to the owners, which was in tern a function of the cost to the real estate developer. The price should be fair. It is unjust if someone pays 400,000 dollars for a home and someone buys it for 200,000. My Initial reaction was what century is this lady living in. It certainly was not the 21st century.

  • St. Thomas Aquinas believed in something called a ‘just price’ based on cost and a just profit. This was in the 13th century. I am Catholic and, one of my favorite thinkers but he did not have a clear understanding of supply and demand.
  • Karl Marx believed there was an objective measure of value, such as the cost of labor put into the object. This was in the 19th century. Started a revolution in thinking that cost the human race 100 million lives not to mention economic poverty for Eastern Europe.

What do I care what some bloke paid for something? All that matters is what value is it to me. He could have paid 1 penny for it, but if I find it of value I might pay 100 dollars. This is economics.

Finding gold example

For example, if I find a gold nugget in a river, should I sell it for what it cost me to pick up and then a 10% margin? Value is always determined subjectively, that is by the price a customer will pay for something. Value is subjective. Value is determined by supply and demand not cost. Not even a little.

Crude artistic example

Another example, if some person, offers to tattoo your chest with a dadaist images of an upside-down toilet with a flower in it, but it will cost me 100,000 dollars because of his artistic skill and the cost that went into obtaining that, would you do it? Of course not. I would not do it for 1 penny. In fact, I find both objectionable. Price is determined by what a person will pay for something, nothing more.

Even if marginal cost equals marginal product is the microeconomics understanding of price, it still comes down to a subjective understanding of value.

Rules to remember about price

  1. Buyers do not care about your cost – I bought some stock and the price is down, when I sell it in the market, the largest auction block in the world, the stock market, no one cares about my personal acquisition cost.
  2. Cost-based pricing impedes your ability to differentiate based on satisfaction, the customer suffers. For example, I like ballet, when I go, I pay for cheap seats because that is what I can afford. Yet richer folks pay for better seats. Now the cost of the seat is the same for the builder, but and owner, but the price is different based on the view. Similarly in Real Estate the cost of a home in a cornfield in Nebraska or Detroit, Michigan is different than in Florida on the Ocean even though the cost to build in Florida might be cheaper, as it does not have to be prepared for winter.
  3. Profits are limited as is innovation with cost-based pricing. – Imagine someone develops a way to make a smart phone thinner, lighter and more user-friendly than the older model, but the same production cost, as an old-style cell phone. Are you telling me I can not charge more, to the consumer who wants a clearer picture and more fun with communication? Where is the incentive to innovate?

Cost pricing is something stuck in the heads of accountants but in the real world, you are paid what someone thinks you are worth and you purchase something based on the same idea. The idea of justice and economics come into play as there is not a fair price for work or goods. Fair is something in a game or gentlemen sport. But economics, says nothing about fairness one the price level.

Where the ideas of economic justice do come into play are giving people the chance to develop their potentials in life and providing a safety net for those disenfranchised in life. I believe this is both a private sector with charities and government initiative and on an international scale.

  • But the price, no, there is no such thing as an unfair price or wage. It is a free county. If you do not want to pay for it and if you are paid to little quit your job.

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