Dr. Cravens is Associate Professor of Agricultural Economics and Rural Sociology at Ohio State University. His article first appeared in the January 1958 issue of Timely Economic Information for Ohio Farmers.
Often, someone says, "They set the price too high." He pictures a mythical "they" as controlling the particular product and, somehow, saying what consumers must pay for it. But, just how true is this picture?
Most folks have attended an auction. Perhaps it was the sale of pies or boxes at a bazaar, or the sale of farm products or household goods. Who sets the price at such auctions?
Many factors affect these auction prices, but they are finally determined by the amount and the quality of goods for sale, the size of the crowd, the bidders’ supply of money, the mood of the occasion, and similar situations. Sometimes the auctioneer will announce that if he cannot get a certain price, the owner will not sell an item. If none of the bidders will pay this price, the owner has set a price that is above the market, and no sale is made. However, the owner has only postponed the sale — if he wants to sell — in hopes that at a later time he will obtain his price.
If the owner does not get his price, he may keep the item or sell it at a lower price. In either case, his setting the minimum price did not force a sale at the set price. The bidders placed their own value on the item.
This simple auction method of price setting is in many ways similar to that of most American businesses today. A good example is the supermarket.
The supermarket operator decides his retail prices — sometimes at near the wholesale or farm prices and sometimes at much higher prices. Anyone who has observed the relationship between retail and wholesale prices has seen this in both individual retail and chain stores.
Setting Apple Prices
Here is how this pricing system works for an individual commodity. By December, each year, producers and food handlers can estimate fairly accurately the quantity of apples available for sale until the next crop. Few consumers are aware of the size of the apple supply. On the basis of experience, farmers and handlers who own apples decide to sell or not to sell at the current price. Their decisions may cause this price to fluctuate, according to the number of apples reaching the market.
The retailer bases his price on this wholesale price. The consumer looks at the retail price and decides whether or not to buy. If her purchases are at a rate too slow to move all of the apples from storage, handlers must somehow speed up the sales.
Usually a lowering of the asking price will bring a consequent increase in sales. It is a continual trial and error process in which the owner of apples keeps one eye on his apple stocks and the other on the rate of purchase by the consumer. He tries to get the highest possible price for his apples, but he must sell them at a price that will move the entire crop out of storage before another harvest.
Each day’s price is tentative —it is based on opinions as to the current and future actions of the consumer. If she buys at a rapid rate, the price stays firm or rises. If she does not buy, or buys at a slow rate, the price will fall. These actions, multiplied by the millions of potential sellers and consumers, set apple prices.
This example shows briefly how prices are set for one product. The method is simply supply and demand at work. The individual consumer does not and cannot know all the factors of supply and demand for each product. However, her influence is the main price-setting force; her rate of purchase forces changes in price.
Price-Setting in Industry
This same basic procedure determines the price of almost every marketed commodity. It even applies to refrigerators or pots and pans, items for which the consumer believes the manufacturer sets the selling price where he wants it. The manufacturer does set the price at which he will sell his product, but he cannot force the consumer to buy. More and more manufacturers are basing their prices on accurate information about production costs and probable consumer purchases at prices based on these costs.
For instance, a company may estimate that at $22 a unit, it can sell 1,250,000 units. At $25, it could sell 1,000,000 units and at $28, it could sell 750,000 units. Of course, these figures are based on what the competition will probably do.
On the basis of estimated per unit costs of production and probable competitive prices, the company must decide at which price to start. Actual production costs may vary from the estimate. In any case, the company must decide on the price and production schedule it believes will best suit its aims.
If the company has correctly estimated the reaction of the competition and the customers to these prices, it will reach its goal. If it has estimated 1,000,000 unit sales at $25, and actual sales are only 750,000, something must change. The company may either sell the remaining 250,000 units at a loss or stop production short of its 1,000,000-unit goal. The decision may involve laying off workers and losing customers to other companies or to other products. In any case the company will either lose money or make less than its aim. Of course, if sales run ahead of expectations, the reverse would be true.
The net effect of this action and reaction is similar to that for pricing agricultural products, except for the length of time between the realization of the need for adjustment and the actual adjustment. The difference is largely in the degree over which the producer has control of his production.
Even though a single grower produced the entire United States crop, the method of pricing apples for a particular season would remain much the same as it is today. The apple producer cannot know until near harvest time how many apples he will market. On the other hand, the appliance producer can more closely control production schedules to meet changing situations.
In our competitive marketing system, anyone can set a price, but he cannot force the customer to buy, nor can he force others to set the same price. The customer is free to select what he, or she, considers the best buy from the many choices available. The exceptions to this principle are almost all due to governmental policies.