• 201904.02

    The mystification of pricing

    Pricing is an important economic tool. How much things cost, and how much things should cost, has been a subject of debate between economists for a long time. However, there’s one part of pricing I’d like to dissect. It’s the aspect of mystification.

    When I buy a product, it sends a signal. It’s essentially an economic feedback mechanism that says “I value this product as much or more than the price that it is being sold for.” This signal is transmitted back to the producer (sometimes over many hops of the economic network because usually you buy a product from a distributor, not directly from the manufacturer). However, the producer does not know why I bought it.

    The price takes into account many different factors: the inputs to production required to make the product, the wages of the people producing it, the marketing budget to convince people to buy it, the costs of compliance with regulations, the need to pay back interest on loans acquired for startup capital, shipping costs, etc etc. There are likely thousands upon thousands of factors that are bundled into the price of a product.

    The problem is, we don’t know what they are. When I buy something, I am saying “I like this for some reason” and that’s the only economic signal the producer receives. I can call them and say “Hey, I love your peanut butter because it tastes better than others” and companies will certainly encourage this, but there is no economic feedback mechanism other than the purchase itself.

    So, if labor costs $5, the inputs to production cost $3, marketing is $1, and the owner of the company wants a profit of $3, that’s 5 + 3 + 1 + 3 = 12. Now, as a consumer, how do I tell how much the labor cost for this product? Or how much profit was made? It’s impossible. You can only find one by knowing all of the others.

    Why is this a problem? It’s a problem because people encourage voting with capital. They encourage spending based on beliefs. But, there’s no economic feedback mechanism in place to vote for just one of the factors of the price of a product.

    Imagine if you had deconstructed pricing for every product. Instead of $5.99 it had $0.03 in environmental compliance, $0.50 in marketing, $1.00 in wages (with a breakdown of labor-hours averaged per-worker), $0.60 in productive inputs (and each input had a deconstructed price as well), $1.67 in equipment maintenance, $0.98 for reinvestment in the company, and $1.21 in profit for the owners.

    Now, pricing is demystified. You can buy a product produced by people who are paid well, or buy products that are made from products made by people who are paid well. You can buy a product that spends more in order to care for the environment. You can buy products that value profit less.

    Would this not be a a requirement of voting with your dollar?


    This thought experiment came out of discussions I’ve have around an economic model I’m working on. One of the ideas I’m interested in is wages being decided democratically based on a set of attributes: social need, skill/training required, stress level, danger, etc. Essentially, each attribute would be a value between 0 and 1, and the average of all the attribute values multiplied by a maximum wage would be someone’s hourly wage. A productivity attribute could be applied to each person such that their occupational wage goes from being fixed to being a range instead, and this productivity rate would be decided by the worker (if self-employed) or the members of their company. The wage attributes would be decided regionally (per-city/county).

    In essence, you give every industry-occupation pair a score and use it to determine the range of wages a person can have. After that, you let the pricing system take over. The purpose here is for society to make a conscious decision on “what this job is worth.” My theory is that the economy would be shaped very differently if people were given a direct choice. Want smarter children? Raise the need for the education industry and for the teacher occupation. Too many tech dorks on scooters? Lower the social need for computer programmers. Making wages a conscious decision of the members of the community allows them to shape their own economy, without having to deal with the wildly inaccurate pricing system and the feedback loops of the market.

    Should a pro football player be paid 500x more than a teacher? I’m willing to bet that if you asked every single person in the United States this question, the answer would overwhelmingly be “no.” Why, then, does the market enforce these patterns?

    After discussions, this idea of democratically setting wages was met with some resistance. It was argued that the market already does allow democratization of wages. People do vote for salaries already, and they do it via the products and services they buy. However, after some thinking, I realized this isn’t true. People certainly enforce economic patterns via their spending, but the truth is that, even if they did want to alter their spending to shape the economy according to their desires, they simply do not have the information they need to do so.

    This is because of the mystification of pricing.

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