A real estate agent relayed to me a story. She went to see a couple wanting to list their house. The couple informed her of the price at which they wanted to list the house. Puzzled the agent asked them where they got such a figure. “Easy” they said. “We just added up all our debt” and this is what we need to pay it off. She burst into laughter.
So how are prices set? For anyone interested in economics this is a great question because the answer is the same regardless of what is being sold, a house, a piece of candy, or even your services to your employer. To think about how the price of something was arrived at is a good start to understanding the economic reality in which we live.
We tend to think that it costs however much to make, say, a loaf of bread, then the store buys it and sells it for a profit. But it’s not quite that simple. The farmer who grew the wheat also hoped to make a profit, as did the truck driver, the baker and so on.
So the question of how a price is derived is not only the chain of costs associated with putting it on the shelf, but also the profits of each of those involved in that chain. As you might imagine this is a lot of people, many that you wouldn’t think of like oil and steel refineries, tractor companies, and so on. It is an extensive list and an extremely complex undertaking. Yet, at the end of the chain, there it is for about two bucks, a loaf of bread. So how are the prices set all along the way?
Well that’s not so complex at all and no different than what you charge your employer really… it’s as much as possible.