Value, Price and Cost

Think about a product or a service you bought recently and why you paid that price for it. For example, if you are a Netflix subscriber you pay about $7.99 every month to have access to that service which means that you value having this subscription more than you value $7.99. If Netflix increased its price to $11.99 people who value the service more than $11.99 will continue to subscribe but if Netflix increased the price to $100 a month they will definitely lose a lot of users. People decide to buy a product or a service if they value it more than they value its price that’s why interactions in the free market are all win-win interactions. People won’t voluntarily enter a transaction they don’t think it will make them better off. The decision to buy a product or a service has nothing to do with the cost of production, but it depends on the subjective value the customer puts into that product or service. Economists call this the Subjective Theory of Value.

A producer sets the price of his product or service to what he thinks will attract enough customers to make up for his business costs and get a profit. If a business cannot make a profit it has to make a change such as optimizing its process to save on costs or increasing its prices and hoping to keep enough customers to get profits. If a business couldn’t make a profit it will eventually just shutting down. When a new business enters a market it competes by offering similar value to existing offerings with less price, offering a better value with higher or same price or offering a less value product at a less price point to attract customers who weren’t part of that market. The free market and the different value different people assign to the same product or service allow different options of products and services to suit most customers.

In the free market, a producer cannot ask for a higher price than what the customers value his product while a customer cannot pay less price than what the producer is willing to offer. Some customers and producers try to force outcomes that cannot be achieved via the free market using government coercion. They influence the government to make it interfere in the market by setting prices of certain products or services. Usually, government intervention causes the exact opposite of what the government aimed to achieve:

  • Price Ceilings: the government decides that the price of some product or service is high so it sets a ceiling on that price. This leads to increase the demand for that product or service because the low price is less than the value more people place on it. But because it is harder to make the profit under that price many producers will either leave the market or lower the quality of their offerings. Rent Control is a classic example, it leads to increase in the demand for apartments in the city that enacts it and a reduction in the supply of rental units and quality deterioration of the existing units because landlords cut on maintenance.
  • Price Floors: the government decides that the price of a certain product or service is low so it sets a floor for the price. This raises the price above what many people value which drives them out of that market leaving much of that product or service unsold. Minimum Wage is a classic example, the government sets the hourly rate of unskilled workers at a rate higher than what many business owners value they don’t higher those workers leaving many of them unemployed.

Politicians use government coercion to interfere in the market to achieve political goals. Although they fail to achieve their stated economic goals, they win the support of voters who wish to buy a product for less than its market price or sell a product for more than its value. The more deviation from the free market they achieve the more problems happen affecting everyone in the economy.