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March 8, 2006

Price and Cost

-- by Dave Johnson

The price of something should reflect the cost. Right? If something costs very little, its price should be low. If something costs a lot, its price should be high.

Have you ever encountered something where the price had an inverse relationship to the cost?

What is the cost of burning oil? First, there is the extraction cost. Then there is the cost of refining the oil into products. Then there is the transport and storage cost.

But there are other, higher costs associated with oil. Oddly, as these costs rise the price of oil drops. The simplest illustration of what I mean is that at times when we pump more oil out of the ground the current supply is greater so the price drops. But what is the cost of pumping more oil out of the ground?

What is the cost of opening up the Arctic wilderness to drilling? More oil is available today, so the price drops.

What is the cost of using up more of the remaining oil? We pump more oil so the price drops, but think about the cost to a future world running out of oil.

As we burn oil we pollute the air. What is the cost? What is the cost in health consequences? What is the cost in CO2 effects like the current melting of the Greenland ice? Scientists say the strength of hurricane Katrina and the record number of hurricanes last year are the result of global warming. That is a cost that was not reflected at the gas station.

What is the political cost? When we buy oil we are financing the Right's network of propaganda organizations. We fund Middle-Eastern dictatorships.

The COSTS of oil seem to have an inverse relationship to the PRICE we pay at the gas station.

Posted by Dave Johnson at March 8, 2006 8:58 AM

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Comments

Oil companies are very adept capitalists. They've managed to socialize many of their costs. Especially the really big ones like destruction of the natural environment and military expenditures to assure unfettered access to foreign raw materials.

Posted by: richard [TypeKey Profile Page] at March 8, 2006 10:03 AM

This is a fairly common fallacy. The price of something and its cost to produce are unrelated. Price is strictly what people are willing to pay for something.

A good example of this is sporting-event ticket prices. They are unrelated to player salaries. Basically, the only reason it's expensive to go to a ball game is that lots of other people do too, and there are only so many seats. Ticket prices have risen lately, but this is true even of college games, where the players are unsalaried. The rise is because more people (who have had more disposable income to throw around) became interested in going to the games.

Most hard goods' prices do not today incorporate the total cost not only of production but also of disposal and reclaimation. That will change when the raw goods are exhausted and have to be reclaimed in the first place, but that's not quite the price vs. cost issue.

Posted by: ctate [TypeKey Profile Page] at March 8, 2006 3:17 PM

The costs of global warming and pollution are borne by society-at-large, while the profits are reaped by a select few.

Posted by: Dave Johnson [TypeKey Profile Page] at March 8, 2006 4:49 PM

I think it's more telling to say that the profits are reaped now while the costs are deferred to some indefinite time possibly far in the future. Selfishness kicks in pretty hard for many people under those conditions.

I agree that this is a Very Bad Thing.

Posted by: ctate [TypeKey Profile Page] at March 8, 2006 10:35 PM

"Price is strictly what people are willing to pay for something."

That's true, but countering that is the basic notion of fairness (which has been established in various economic experiments -- see Oswald and Zizzo's experiment on 'burning') which seems to indicate people do sometimes consider what a thing costs when they consider what they're willing to pay for it.

Posted by: ArC at March 10, 2006 12:31 PM

Um, coffee at some places.

Posted by: The Heretik at March 10, 2006 12:36 PM

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