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Left Coast / Right Coast: The Insanity of Pricing

There are a lot of things that make perfect sense economically. Likewise, there are a lot of things that don’t. I got to thinking about this earlier this week as I read about gasoline prices inching up.
Mike Gold living the dream in the Pacific Northwest. Photo credit: Nancy Gold.

By Mike Gold, A retired entrepreneur living the dream in the Pacific Northwest.

There are a lot of things that make perfect sense economically. Likewise, there are a lot of things that don’t.

I got to thinking about this earlier this week as I read about gasoline prices inching up. If you look at the gasoline market from the 10,000 -foot level, you will notice certain things.

First off, in the long term it is virtually impossible to be at odds with the law of supply and demand. That simply stated says that (this is Economics 101) if the supply of anything remains fixed while demand for the item goes up, so must the price go up.

In reverse, if the supply remains fixed but demand goes down, the price must go down. So why are gas prices increasing now? Simple, we’re entering the warmer driving season. Demand goes up, supply can only increase so much. Also, in many parts of the country, the “summer blend” – more ethanol in the gas hence more expensive to produce.

Now without getting into economic theory (it is quite boring – please believe me), these basic economic principles can vary.

For example, I’m sure we’d all like to own and drive a Ferrari. Now the least expensive model is priced at $214,533 plus tax (!)  I have always wondered why a “car” could possibly be priced that high. After all, any car, Ferrari included, consists of a chassis, running gear (engine/transmission/differential), wheels and tires and all the other “normal” stuff that makes up an automobile.

Now is the engine made of titanium? Hardly, same metal castings plus pistons, crankshaft, camshafts, electronics, etc.

Do the engineers that design the engine make triple what engine designers make at other automobile companies? Again, hardly. Same question and answer for all the other major pieces of a Ferrari. In fact, in many cases Ferrari purchases major parts (example, wheels and tires) from third party companies, the same suppliers that every other carmaker uses.

Perhaps the most understandable part of the price is the law of supply and demand. Ferrari makes so few cars that they have to amortize the development costs and actual labor costs over a much smaller number of cars than most other car companies. So that raises the “per car” cost. But that would not come to the almost ten times per car cost of Ferraris vs. “normal” cars, Chevrolets, Hondas, etc.

So, what else causes such a high price? Desirability! It is actually part of the same law of supply and demand. If you make a product that is so highly desirable such that everyone wants one, that increases demand while supply remains relatively fixed. Therefore, Ferrari prices their cars to reflect the uniqueness of their models.

In fact, at various times in Ferrari’s past, they have made a model that at its launch date became an “instant collectible.” The Daytona model was such a car.  Although when new the model cost approximately $150,000, today any decent used model goes for at least $600,000 up to $1 million.

See, that model is so sought after by collectors that the market has set a very high price per car (even though almost all cars decrease in value as they age). Very high demand, very limited supply.

I remember when Beanie Babies were all the rage. Ty Inc., the manufacturer, figured out that they could artificially restrict the number of specific model of BB making it much more desirable. The Britannia Bear was such a unit. You could not find one for sale just about anywhere in the U.S. There was no Craigslist back then, but you could find them for sale in the classified ads of your newspaper. Typical price was over $100 even though the “list price” was about $15. I remember having our U.K. rep buy one over there and ship it to our U.S. address.

Now this madness went amok back in the 1600s in Holland and all of Europe. It was called Tulip mania.  Certain tulips sold for more than the price of a canal front home in Amsterdam.

Like any “free market,” what goes up must come down. Remember the gasoline shortage in the 1970s (thank you Jimmy Carter). If you could find gasoline to purchase, often the price then was over $5 per gallon (after inflation today’s price would be over $10 per gallon). Every single car owner sought to keep their tank topped off. So the shortage was exacerbated by everyone getting in line even when their tank was over half full. Fist fights broke out if someone tried to cut in line.

Well guess what, a month or so after this, the Arabs re-opened up their spigots. Within a week or so, gas was available (no lines) just about everywhere and back at “normal” prices for then (perhaps $1 per gallon).

The best advice I was given as a young man was: “If it is over-priced, do not buy, instead sell.” In fact, that is exactly Warren Buffets investment guide: “Buy low, hold on just about forever and sell high.

Instead, the small investor often “panics” when the market drops. They get so scared; they sell as the market drops, which across the entire market causes prices to drop even faster. Again, don’t panic. Just hold on and time will fix it. Time wounds all heels.

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