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What Determines the Price —
Production Costs or Consumer Demand?
© 2001 Stuart Daw
(appeared in Canadian
Vending April 2001)
My Toronto office telephone rang at 1:40 on an
afternoon in 1994. It was CNBC in New York wanting to know if I could be there
for the 6:00 p.m. national program Business Insider. A quick trip to the
airport, the last seat on a flight to Newark, a late arrival, a temporarily
missing NBC chauffeur, a New Jersey rush-hour and I was at the studio at 5:45,
just in time to be whisked into the makeup room and onto the set!
Awaiting me were the show's host, Neil Cavuto,
Newsweek reporter Bill Walman, and Richard Kessel of the "New York Consumer
Protection Board," a prime example of the modern consumerist - no knowledge
of or concern for the economics of production - only for the consumption side of
the equation.
The question that inspired that night's
program: Why did a frost in Brazil after the harvest was mostly in, cause an
immediate rise in coffee prices at the retail level? After all, the shortage, if
there was to be one, wouldn't come until next year.
This was "deja vu all over again,"
for I had been on ABC’s David Hartman Good Morning America show twice
in 1977 on the same subject, once against Eleanor Guggenheimer, New York
consumerist advocate at the time, and once against the late congressman Benjamin
Rosenthal, who wanted to regulate roasters. They shared a common
misunderstanding about price theory, including that pertaining to coffee.
In recently reviewing the video tape of that
program, I kind of liked one exchange that took place between Kessel and me. I
asked him: "If coffee cost a dollar a pound, and you sold it for two
dollars, but had to buy new inventory at three dollars a pound, did you make a
dollar or lose a dollar?" His answer: "You’re not the
moderator."
"Then I’ll tell you," I said.
"You made a dollar on paper and lost a dollar in cash, and then had to pay
income tax on the dollar you never saw." To which the moderator said,
"I’ll have to play back the tape to get that one again."
The practical point was that for Kessel, the
fact that welfare recipients in New York had to pay more for their coffee was
immoral, as long as Folgers, Maxwell House and others still had inventory bought
at lower prices. And until the new, higher priced green coffee arrived in their
warehouses they were morally bound to keep prices where they were. The question
of where the money would come from to buy new inventory would never occur to
minds like theirs.
Yet they were no different than the general
public who have been taught that selling prices should reflect the cost of
production, with a very modest profit perhaps allowed. The truth is that the
market, the laws of supply and demand, is the only way to ensure continuity of
availability in any product.
After a frost in Brazil a perception of future
shortage causes green coffee prices to spike up overnight. Roasters are
immediately subject to these higher costs, and how can they afford to pay them
if they haven’t raised prices on current inventories? To say that Procter
& Gamble (Folgers) and Phillip Morris (KGF-Maxwell House) can use the money
they make from Tide, Bounty paper, dog food or tobacco, is to advocate a lower
form of morality I’d rather not deal with here.
Arguments with consumerist groups on this
issue unfortunately are difficult to win on ethical grounds, given the dominant
moral premises of self sacrifice prevailing in the social system today. Luckily
however it can be fought on practical grounds as well, for the good news in all
of this is that THE MORAL IS THE PRACTICAL. By raising prices in the above
example, world consumption declines to that level at which demand and supply are
in equilibrium, so there is always coffee on the store shelf in a semi-free
society like ours (unlike the old Soviet Union where, if you could find any at
all, you lined up for hours to buy a loaf of bread).
The same lesson applies to any commodity. If a
hurricane in Miami is the cause of, say, a temporary shortage of drinking water,
politicians mount the barricades to scream for price controls to prevent
entrepreneurs from "ripping off the public." Yet it is only the
prospect of higher prices that persuades the "rip-off artist" to rush
into the breach, water tanks squirting forth with the very manna that will save
the day by ensuring water for all, with lower prices the ultimate result.
Ironically, the free market supplier, the
guarantor of product availability and value, acts in the best interests of the
consumer although, as Adam Smith would say, "It is no part of his
intention." Today coffee is in over-supply, and various programs are being
attempted by coffee exporting countries bolster prices. The answer is being
found in high quality for, even as prices for lower grade offerings have fallen,
the "differentials" over the "C" Contract on the New York
Coffee, Sugar and Cocoa Exchange that we have to pay to obtain the quality our
customers demand, keep rising. The old Ford Motor slogan "Quality and
Demand Go Hand in Hand" applies to those in the coffee business as well.
© 2001 Stuart Daw |
