Imagine walking into your local Tim Horton’s and ordering your usual hot cup of coffee, the barista rings you up and tells you that your total comes out to be $100.00. Taken aback by this ludicrous price you decide to walk across the street to the Starbucks where you order your Venti chai latte with extra foam for $7.99. Many people would agree that the $100.00 coffee at Tim Horton’s is ridiculously overpriced and that no sane person would spend that much for a coffee but as an economist it is interesting to ask oneself if there even is a possibility for something to be overpriced. In order to answer this seemingly straightforward question one must first ask oneself what constitutes something for being overpriced in the first place, or even more general question as to how prices are set.
You may think that as long as the price is set above costs a profit is made and even more in depth when looking at classical economics the desired price is one that meets the price of which the demand and supply will support an equal quantity of units sold.
Using the supply and demand chart in this context, if a price is set higher than what its customers demand then the company would be lead with an excess quantity of product, being faced with the need to lower its price to its equilibrium for maximum efficiency.
Seems simple enough right? But that does not explain how some companies are allowed to sell seemingly overpriced products and still ‘get away with it,’ the solution to this puzzles relies on the most complex piece of them all… human nature!
In reality, when determining the price for an item much more decision making is necessary and a large portion of it relies on psychological factors of spending when it comes to consumers. The bottom line is this: when we buy something we don’t usually see what we pay for.
Before you start scratching your head, try asking yourself why popcorn at movie theaters cost far more than ones at the store but cease to fail in drawing customers. Assuming that both quality and quantity of store bought popcorn and movie popcorn are the same then there must be something more that is driving up the price and that being one of the unseen factors of convenience. Areas in which people are more likely to pay more for products at their earliest convenience are those in which you can observe some of the highest prices. Many items in which are highly regarded in being ‘overpriced’ ride exactly on this bandwagon of being in the exact atmosphere such as movie theatre popcorn, hotel minibars, and coffee (from a cafe). A large percentage of people simply do not want to be bothered enough to take greater measures for a lower price.
This still doesn’t explain for the products that don’t offer such services but still manage to be considered ‘overpriced.’ Going back to the idea of our strange human nature, tests have shown that people actually enjoy spending more money(!). This isn’t to say that you will be happier if I am now charging you $100.00 for this cup of coffee instead of $7.99 but more to do with the notion that since you are spending more you believe that you should be experiencing an equal or greater amount of pleasure. Economist and author Tim Harford explains this phenomena when discussing the topic for which priced wine should a consumer buy, he writes:
“You assume that the price of the wine and its quality can be neatly separated out. This seems reasonable, but is wrong. Price changes the very experience of quality. Neuro-economists have found, for instance, that while placebo painkillers work, they work best if the subject thinks they are expensive. Energy drinks give you less energy if you buy them at a discount. (Yes, really.) And of course, wine tastes better if you believe that it is expensive.”
If this all starts to be making sense then you may be asking then how come everything in our world isn’t priced higher? It’s important to remember that people will only buy things they feel that is worth spending, what in question is though is how people decide on that value. Although we think we may rationally decide this value based on cost of production of the product, in reality we far more reference arbitrary benchmarks from past experience than anything else. Researchers call this the “anchoring effect” and it refers to the human tendency to fixate ourselves on initial values (anchor points) and estimate from that point on. This tendency is used and abused by companies all the time as we never truly know the true value of the items produced, like the cost of all the parts in a car, or total manufacturing process of a handbag; instead we’re simply given a carefully thought out number to help manipulate our decision making process. This doesn’t mean that Walmart should be selling $400 bags in order to be able to raise the demand of their other bags. The reason some companies are able to set their benchmark so high is due to luxury marketing philosophies that seem counter intuitive at first glance, but work very effectively to appeal to our irrational human nature. Vincent Bastien, a marketing professor, who worked with companies such as Louis Vuitton regard these “anti-laws of marketing” as powerful strategies to increase brand recognition. By making products associated with factors such as being difficult to buy,Increase in value over time, unresponsive to rising demand and being known to consumers who are not target market, a brand name is made and desire is formed.
So even though the economic model of supply and demand says that equilibrium price is most optimal in reality, it isn’t necessarily the best choice. Products cannot be overpriced but they can only do so in the right context. Before you go running to make your $100 a cup cafe remember that high prices with low costs still have meaning and reason behind it. By pinpointing external factors such as location, comfortability, or internal such as brand recognition, or imitated experience, a company can effectively increase the cost of any product and it would not be overpriced.