Why Do Some Things Cost More?

At one time, when buying a car, cloth upholstery on the seats was standard, but for extra cost, you could get vinyl upholstery. At a later period, vinyl was the standard or base choice, and cloth was an extra-cost option.

In the Middle Ages, white bread was more expensive and was perceived as a luxury. Today dark bread costs more than white bread.

In these two cases, the price is not determined by the cost that the manufacturer or provider incurs in producing a product, as the same thing probably is not cheaper to make at one time and more expensive to make at another time. So with some items, at least part of the price is determined by what the buyer will pay (or is expected to be willing to pay).

Why does one bottle of wine cost $7.50 and another $75? There may be greater cost incurred in producing the more expensive wine in that the vintner may pay more for better quality grapes. But most wine experts will acknowledge that price and quality don't have a perfect correlation.

Pricing on the part of a capitalist is to some degree a function of cost of production, but clearly not always. A car, for example, is priced by a major automaker such that, if they make (and sell), say, 100,000 cars, they make a profit. If they sell fewer, they lose money. If they sell more, they make a greater profit. The cost of designing the model, testing it, etc., is amortized over a certain number of units sold. So if a car, or anything else that has design and development costs, stays in production for years, the sale price contains more profit since development costs have already been recouped. Sometimes, even—probably rarely—once the manufacturer's development costs have been recouped, the price may come down, as happened with the Model T Ford.

So is the $75 bottle of wine worth its price, or is it overpriced? Are high-priced items in general worth what they cost?

I can tell you that, as price goes up, the increment in quality is not proportional. For example, what is the difference between a $200 men's suit and a $500 men's suit? You may guess that the more expensive suit is not two and one-half times as "good" in any sense. The latter might have, say, $30 more cost in the cloth and maybe another $20 or so in added labor (more steps or slower and more careful workmanship). So the maker puts in $50 of additional cost and can raise the price $300.

So is that $500 suit a rip-off? Can a $300,000 Ferrari be worth the cost? To some degree you pay for labels and nameplates. Some brands (and stores) have greater profit margin. A Tommy Hilfiger shirt that might cost four times as much as a shirt at Target is still made in Third World countries, with low labor costs. Guess what? It's got greater profit margin. The store that is selling that Hilfiger shirt in an end-of-season sale, at half price, is still not losing money.

In the case of the Ferrari, this is a low-volume car, and largely hand-made. That partly justifies the cost. To the buyer, I'd say: If you can perceive and appreciate the difference between a Ferrari and a Chevrolet, or the subtleties in that premium bottle of wine, and you can afford it, go for it. We need you to keep the economy rolling.

One footnote: I have not attended business school. My information on the suits used as an example comes from very good authority. And I think I'm on solid ground in the rest of what I say here. But if a reader can show me that I am wrong at some point, I hope s/he will tell me so in a comment.

Copyright © 2009 by Richard Stein