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GGP said the price is only determined by how much people are willing to pay. This is obviously false. If the cost of producing a product rises above the current

GGP said the price is only determined by how much people are willing to pay. This is obviously false. If the cost of producing a product rises above the current price, even if the price people are willing to pay doesn't change, the price has to increase or else the business will start losing money.

ncmncm 5y ago
And, sometimes the business starts losing money. We saw that when oil prices went below many producers' extraction cost. They continued selling at the lower price, because they had to service existing debt, and accumulated more debt until the price went back up.
- skeeter2020 5y ago
  This is also known as the "Groupon Business Model of Imminent Failure". Cash today is way more important than accounts receivable.
- Ekaros 5y ago
  Also sometimes supply or production is inelastic and not possible to scale down and up. Thus to have chance to generate money in future they had to accept loss now.
- mannerheim 5y ago
  My understanding with respect to the oil industry is that they have relatively high capital costs, and lower marginal costs. If prices drop so that they become unprofitable, it still makes sense to drill because the fixed costs are already sunk. It could also make sense if you expect the low prices to be a temporary situation, and shutting down and restarting would be expensive. Either way, producing at a loss is not sustainable in the long run, so without costs falling or prices increasing, they would eventually go out of business. This isn't really a factor for Arizona, since as a brand, not a commodity, they can set their price, and since they're cheaper than many of their competitors, they have room to work with here, too. If their unit cost is higher than their unit price, they don't expect costs to decrease, and they don't intend to raise their price, they would simply make more money by not making the product.
jjeaff 5y ago
They will never raise the price higher than people are willing to pay or else they won't sell the product at all. Sometimes they will sell at a loss temporarily and sometimes they will just sell off all remaining product at the highest amount people are willing to pay. Even if at a loss because getting something is better than the product sitting on shelves. Some products are sold at a loss permanently as a loss leader. Like hot dogs or roast chicken at Costco.
- Jensson 5y ago
  > They will never raise the price higher than people are willing to pay or else they won't sell the product at all That isn't true, at least for some definition of "people". They will raise the prices until selling is profitable even if most people aren't willing to pay that, since there will be some who want the product more who pay the premium. If it was profitable to sell for the lower price they probably would make more money thanks to higher volume though, which is why they had the price originally. Supply vs demand isn't always right, but it is closer to right than wrong in most cases. You can look at profit margins to see how well supply/demand works in a specific field, in software supply/demand doesn't exist no. But in most fields profit margins doesn't look like that, they are sub 10% meaning that for every 10 dollars you pay less than 1 dollar goes as profits and the rest goes to pay for the service you bought, that wouldn't be true if prices usually followed what people are willing to pay instead of being a mix of supply/demand.
- mannerheim 5y ago
  Different people have different prices they're willing to pay for a product. That's the theory behind a demand curve. And in reality, if they raise the price to $1.29 or $1.49, there will still be people buying it. If the unit cost of Arizona tea ever went above the unit price, it simply would not make sense to continue manufacturing the product and selling it at that price, outside of contractual obligations. Loss leaders are a different analysis, and in order for that to work, Arizona would have to convince all retailers to sell the product at a loss; Costco's business is not selling hot dogs or rotisserie chicken, and that's why they can afford a loss on those. Even these, they still put in a lot of work to keep costs low (e.g., making the hot dogs themselves instead of buying from Hebrew National), so the loss in recent years has been either small, or they break even. But obviously even this isn't something that could be kept up forever, given long run trends in inflation; the purchasing power of a dollar was ten times greater in 1950, and if in 2090 they keep selling hot dogs for $1.50 when a comparable meal costs $15, it might make sense to have a Costco membership just for hot dogs and rotisserie chickens (unless they set the membership cost so high that it's unrealistic to recoup the cost in a year without, e.g., eating there every single day), and at that point their loss leader just becomes a loss. One final note I'll make is that average hourly earnings over the last couple decades have outpaced the rise in prices for most goods, even as the price of services outpace average hourly earnings; intuitively, the former should make sense, since with improved technology, the same good requires less labour to make. So food has gotten cheaper in real terms over the last few decades, as has shipping, while the opposite effect happens with services because of Baumol's cost disease. Because of this, even with inflation, more efficient products has somewhat blunted the impact on these manufacturers' costs, even though they too will one day have to increase their prices as well.

ncmncm 5y ago

And, sometimes the business starts losing money. We saw that when oil prices went below many producers' extraction cost. They continued selling at the lower price, because they had to service existing debt, and accumulated more debt until the price went back up.

skeeter2020 5y ago
This is also known as the "Groupon Business Model of Imminent Failure". Cash today is way more important than accounts receivable.
Ekaros 5y ago
Also sometimes supply or production is inelastic and not possible to scale down and up. Thus to have chance to generate money in future they had to accept loss now.
mannerheim 5y ago
My understanding with respect to the oil industry is that they have relatively high capital costs, and lower marginal costs. If prices drop so that they become unprofitable, it still makes sense to drill because the fixed costs are already sunk. It could also make sense if you expect the low prices to be a temporary situation, and shutting down and restarting would be expensive. Either way, producing at a loss is not sustainable in the long run, so without costs falling or prices increasing, they would eventually go out of business. This isn't really a factor for Arizona, since as a brand, not a commodity, they can set their price, and since they're cheaper than many of their competitors, they have room to work with here, too. If their unit cost is higher than their unit price, they don't expect costs to decrease, and they don't intend to raise their price, they would simply make more money by not making the product.

jjeaff 5y ago

They will never raise the price higher than people are willing to pay or else they won't sell the product at all. Sometimes they will sell at a loss temporarily and sometimes they will just sell off all remaining product at the highest amount people are willing to pay. Even if at a loss because getting something is better than the product sitting on shelves. Some products are sold at a loss permanently as a loss leader. Like hot dogs or roast chicken at Costco.

Jensson 5y ago
> They will never raise the price higher than people are willing to pay or else they won't sell the product at all That isn't true, at least for some definition of "people". They will raise the prices until selling is profitable even if most people aren't willing to pay that, since there will be some who want the product more who pay the premium. If it was profitable to sell for the lower price they probably would make more money thanks to higher volume though, which is why they had the price originally. Supply vs demand isn't always right, but it is closer to right than wrong in most cases. You can look at profit margins to see how well supply/demand works in a specific field, in software supply/demand doesn't exist no. But in most fields profit margins doesn't look like that, they are sub 10% meaning that for every 10 dollars you pay less than 1 dollar goes as profits and the rest goes to pay for the service you bought, that wouldn't be true if prices usually followed what people are willing to pay instead of being a mix of supply/demand.
mannerheim 5y ago
Different people have different prices they're willing to pay for a product. That's the theory behind a demand curve. And in reality, if they raise the price to $1.29 or $1.49, there will still be people buying it. If the unit cost of Arizona tea ever went above the unit price, it simply would not make sense to continue manufacturing the product and selling it at that price, outside of contractual obligations. Loss leaders are a different analysis, and in order for that to work, Arizona would have to convince all retailers to sell the product at a loss; Costco's business is not selling hot dogs or rotisserie chicken, and that's why they can afford a loss on those. Even these, they still put in a lot of work to keep costs low (e.g., making the hot dogs themselves instead of buying from Hebrew National), so the loss in recent years has been either small, or they break even. But obviously even this isn't something that could be kept up forever, given long run trends in inflation; the purchasing power of a dollar was ten times greater in 1950, and if in 2090 they keep selling hot dogs for $1.50 when a comparable meal costs $15, it might make sense to have a Costco membership just for hot dogs and rotisserie chickens (unless they set the membership cost so high that it's unrealistic to recoup the cost in a year without, e.g., eating there every single day), and at that point their loss leader just becomes a loss. One final note I'll make is that average hourly earnings over the last couple decades have outpaced the rise in prices for most goods, even as the price of services outpace average hourly earnings; intuitively, the former should make sense, since with improved technology, the same good requires less labour to make. So food has gotten cheaper in real terms over the last few decades, as has shipping, while the opposite effect happens with services because of Baumol's cost disease. Because of this, even with inflation, more efficient products has somewhat blunted the impact on these manufacturers' costs, even though they too will one day have to increase their prices as well.