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Monday, January 22, 2007

People really just don't get it

Posted by: Jambo / 4:26 PM

Actually there are lots of things people don't get but the one getting me today is basic microeconomics. Last Friday D sent me a couple articles about the new iPhone from Apple and how it is a rip off because the $500 price is twice the $250 production cost.

iPhone Only Costs $250 to Make; Rest of Price is Fanboy Tax

50-percent of your iPhone purchase to pad Apple's wallet?

One of the articles is followed by a string of comments talking about things like R&D they are not reflected in the production price, which is true but completely misses the point. Now I don't want to to be pedantic about this, but it's just that I see the type of faulty reasoning displayed in the article all the time. The truth is the price an item sells for has almost NOTHING to do with what it costs to make it. When a company sets a price they don't just figure what it cost to make it and then add 10%. What they do is figure how many people will buy it at various prices and then pick the price that brings in the most revenue. That could be a very high price or a very low one depending on the product.

Say product A cost $50 to make. If it is priced at $60 then 100 people will be willing to buy. If it is priced at $100 then only 50 people will buy it.

Product B also costs $50 to make. If it is priced at $60 then again 100 people will be willing to buy. But If it is priced at $100 then only 10 people will buy it.

Clearly the better price for A is $100 while the better price for B is $60. Neither is a rip-off or a steal, they're just the most logical price to charge. Apple is betting that they will make more money if they sell the iPhone for $499 than they will if they sell it for $399, but they are also betting that they will make more money at $499 than at $549 (figuring that the higher price will decrease sales enough to offset the gain of $50 per phone.) They may be right or wrong about the price but it doesn't really depend on the cost of production.

As an Apple stock holder I hope they successfully set the price where it brings in the most revenue. As someone who thinks the iPhone is one to the coolest f'n things he's seen in a long time I hope that price ends up being lower than $500.

[Yes, I realize that changes to the cost of production DO ultimately alter the actual optimum price as it has some effect on the revenue from each sale, but those effects are at the margin and don't really change the logic of the argument.]

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Sometimes, though, the price dictates everything upstream. In other words, price is the first decision. The Wii was originally designed to be a $199 machine. All the engineering decisions were made to fit that price point.

The price point eventually slipped, but that, curiously, was not really Nintendo's decision. Retailers objected to a $199 price because they wouldn't make enough to push the console. So Nintendo had to bump the price to $249 so the retailers would make enough money to go ahead and sell the game.

By Blogger Hammer, at 9:14 PM  

Jambo's a liberal worth listening to. Why? Because he's got an economics degree, and that makes all the difference. Generally speaking, people without a strong (or some) background in economics should for the most part be seen and not heard.
I love ya, man.

By Anonymous therealrepublican, at 5:29 PM  

You know, those marketing SOBs probably had a say in the price -- you OK with that?

By Blogger Joseph, at 11:02 PM  

I usually just nod and agree with Jambo in terms of economics but I distrust him in matters Apple. His unending allegiance to Overlord Jobs gets to be a little frightening. If William Shatner were ever to play Steven Jobs in a movie, Jambo might die from a fatal nerdgasm.

By Blogger Jerjo/Carjo, at 11:14 AM  

The sad thing is that this post represents a good 75% of everything I remember from my college econ classes. I had a whole semester class on internation trade and all I can really recall is some slim bit about comparative advantage. Still, that's enough to make me more of a free trader than the typical Democrat.

Jerjo, the real problem comes with the Apple movie staring Scarlett Johansson as Steve Jobs.

By Blogger Jambo, at 2:55 PM  

Oh, that's a totally different kind of nerdgasm.

By Blogger Jerjo/Carjo, at 7:45 PM  

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