The Price of Everything Read online

  Wine without a price tag doesn’t have this effect. In 2008, American food and wine critics teamed up with a statistician from Yale and a couple of Swedish economists to study the results of thousands of blind tastings of wines ranging from $1.65 to $150 a bottle. They found that when they can’t see the price tag, people prefer cheaper wine to pricier bottles. Experts’ tastes did move in the proper direction: they favored finer, more expensive wines. But the bias was almost imperceptible. A wine that cost ten times more than another was ranked by experts only seven points higher on a scale of one to one hundred.

  Sometimes people pay stratospheric prices for humdrum items because doing so proves that they can. As the price of oil soared to around $150 a barrel in the summer of 2008, Saeed Khouri, a twenty-five-year-old businessman from Abu Dhabi, made it into Guinness World Records for having bought the most expensive license plate ever. Khouri paid $14 million for the “1” tag in a national license plate auction that drew Rolls and Bentley owners from around the kingdom. The number one is, to be sure, a nice digit to have stamped on a piece of plastic attached to the front and back of a car. But it is hard to argue that the number alone merits a premium of $13,999,905 over the standard fee for a regular license plate.

  This behavior is surprisingly common, however. Paying high prices for pointless trinkets is just an expensive way to show off. In his famous Theory of the Leisure Class, the nineteenth-century American social theorist Thorstein Veblen argued that the rich engaged in what he dubbed “conspicuous consumption” to signal their power and superiority to those around them. In the 1970s, the French sociologist Pierre Bourdieu wrote that aesthetic choices served as social markers for those in power to signal their superiority and set themselves apart from inferior groups. Anybody can buy stocks. Oligarchs, emirs, and hedge-fund managers can pay $106.5 million for Picasso’s Nu au Plateau de Sculpteur, which sold in only eight minutes and six seconds at an auction in New York in May of 2010. Had Mr. Khouri paid ninety-five dollars for a license plate, he could have been anybody.

  Over the last three decades, evolutionary biologists and psychologists picked up on Veblen’s and Bourdieu’s ideas and gave them a twist. The point of spending huge sums on useless baubles is not merely to project an abstract notion of power. It serves to signal one’s fitness to potential mates. Wasteful spending on pointless luxury is not to be frowned upon; it is an essential tool to help our genes survive into the next generation. Sexual selection puts an enormous value on costly, inane displays of resources. What else is the peacock’s tail but a marker of fitness aimed at the peahens on the mating market? It is a statement that the bird is fit enough to expend an inordinate amount of energy on a spray of pointless color.

  A diamond ring has a similar purpose. N. W. Ayer, the advertising agency behind “A Diamond Is Forever,” which crafted the marketing strategy for the global diamond cartel De Beers in the United States, persuaded American women to desire big diamond engagement rings, and men to buy one for them, by convincing them that these expensive bits of rock symbolized success. They gave big diamonds to movie stars and planted stories in magazines about how they symbolized their indestructible love. And they took out ads in elite magazines depicting paintings by Picasso, Derain, or Dalí to indicate that diamonds were in the same luxury class. “The substantial diamond gift can be made a more widely sought symbol of personal and family success—an expression of socio-economic achievement,” said an N. W. Ayer report from the 1950s. Today 84 percent of American brides get a diamond engagement ring, at an average cost of $3,100.

  In 2008 Armin Heinrich, a software developer in Germany, created the ultimate Veblen good: he designed an application for the iPhone called I Am Rich. It did nothing but flash a glowing red gem on the screen. Its point was its expense: $999. Maybe stung by criticism over its banality, Apple removed it the day after its release. But before it could pull it, six people had bought it to prove that, indeed, they were.

  A HISTORY OF PRICES

  Value—what confers it, what it means—has captivated thinkers at least since ancient Greece. But the concept then was different from that of contemporary economics. For hundreds of years, the analysis of value began as a moral inquiry. Aristotle was sure things had a natural, just price—an inherent value that existed before any transaction was made. And justice was the province of God.

  Throughout the Middle Ages, when the Catholic Church regulated virtually all corners of economic life in Europe, scholars understood value as a manifestation of divine justice. Inspired by Saint Matthew’s notion that one should do unto others only what one would have them do unto oneself, Thomas Aquinas stated that trade must convey equal benefits to both parties and condemned selling something for more than its “real” value.

  In the thirteenth century, the Dominican friar Albertus Magnus posited that virtuous exchanges were those in which the goods that were transacted contained the same amount of work and other expenses. This idea was refined into the principle that the inherent value of goods was set by the work that went into them.

  The Church gradually lost its grip on society as trade and private enterprise expanded throughout Europe. Religious dogma lost its appeal as an analytical tool. Still, the penchant to view prices through the lens of justice survived the development of capitalism, thriving well into the eighteenth century. Adam Smith and David Ricardo, the two foremost thinkers of the classical age of economics, struggled with the notion of inherent value, which they viewed as a function of the labor content of products, distinct from the market price set by the vagaries of supply and demand. Smith, for instance, argued that the labor value of products amounted to whatever it cost to feed, clothe, house, and educate workers to make them—with a little extra to allow them to reproduce.

  But this line of argument got stuck. For one, it had no role for capital. Profits were an immoral aberration in a world in which the only value could come from a worker’s toil. Moreover, it didn’t seem to square with common sense. In Ricardo’s day critics were harsh on the labor theory of value. Some pointed out that the only thing that made aged wine more valuable than young wine was time in a cellar, not work. But before the idea could die, Karl Marx took it to what seemed like its logical conclusion. He used the labor theory of value as a basis for the proposition that capitalists used their leverage as the owners of machinery and other means of production to filch value from their workers.

  A product, Marx maintained, is worth all the labor that went into making it, including the labor used to make the necessary tools, the labor in the tools used to make the tools, and so forth. Capitalists made money by usurping part of this value—paying workers only enough to guarantee their subsistence and keeping the rest of the value they created for themselves. This line of thinking could easily lead a thinker astray. Marx concluded that despite appearances, the value relation between different things—their relative price—had nothing to do with the properties of these things. Rather, it was determined by the labor time that went into them. “It is a definite social relation between men that assumes in their eyes the fantastic form of a relation between things,” he wrote.

  This shares some of the cool strangeness characteristic of mystic thought, where things are representations of some deeper phenomenon underneath the skin of reality. But it sheds no light on why I find a glass of cold beer so much more valuable than a glass of warm beer on a hot day. I will buy a head of lettuce if its use value to me—because it is crunchy, fresh, and healthy—is higher than its price, what I have to forgo in order to get it. But if some desperate lettuce lover accosts me on my way home to offer twice what I paid, I will sell it to her at that higher price. There is no mysterious relationship between its intrinsic value and its market price. There are just two people who take different degrees of satisfaction from eating lettuce.

  There’s a cool trick that teachers have used for years to expose students to the power of this transaction. First they distribute bags with assortments of candies among their
students and ask them how much they value the gift—what would they be willing to pay for their stash? Then they allow them to trade candy among themselves. If students are asked again after the exchange to assess the value of their booty, they will invariably give it a higher value than the first time. That’s because trading allowed them to match their lot to their preferences. They traded things they valued less for things they valued more. Nobody worked, yet the value of the entire allotment of candies grew.

  The realization that things do not possess an absolute, inherent value seeped into economic thought in the nineteenth century. Marx’s labor theory of value eventually faded into irrelevance as nobody could figure out how his concept related to the prices at which people voluntarily bought and sold real things. Things are costly to make, of course. This puts a floor on the price at which they are supplied. But the value of a product does not live inside it. It is a subjective quantity determined by the seller and the buyer. The relative value of exchanged things is their relative price. This realization lifted prices into their rightful spot as indicators of human preferences and guides of humankind.

  TAMING PRICES

  Two people will be willing to trade one good for another as long as the perceived benefit from owning one more unit of what they get—the marginal gain—is at least as much as the lost value of what each trades away. This gain, in turn, is determined by the buyer’s endowment of goods: money, time, and whatever else might come into her calculation. The more one has of a given thing, the less one will value having one more. This single principle is the organizing force of markets, which determines the prices of goods and services around the world.

  In a market, sellers’ priority is usually to squeeze as much money as possible from buyers. Buyers, in turn, will try to get stuff they want as cheaply as they can. They each operate within a set of constraints: for buyers a budget; for sellers, the cost of producing, storing, advertising, and bringing to market whatever they make. While producers can raise prices if consumer demand for their good grows faster than its supply, consumer demand will wane as prices rise. Above all, producers’ space to raise prices is constrained by competition. In a competitive market consumers can safely assume that prices will be kept in check as rival producers vying for consumers’ custom force them down to their marginal cost, the cost of making one more unit.

  There are lots of exceptions to this dynamic, however. To begin with, fully competitive markets are rare. In markets for new inventions, legal monopolies called patents allow companies to charge higher prices than they would in a competitive field in order to recover the up-front cost of their invention. Local monopolies are common—think of the popcorn vendor inside the movie theater. Even in markets for run-of-the-mill products, producers will do their best to keep competition at bay. A tried and tested tactic is to convince consumers that their product is unique, muddying comparisons with rivals’ wares. Another is to lock in consumers with a cheap product that, it later becomes apparent, only works in conjunction with some higher-priced good. Another is simply to hide their prices from consumers’ view.

  Unacknowledged motivations cloud the assessments of value that drive our daily decisions. My monthly dues of $58.65 at the New York Sports Club next to the office mean that each of my twice-weekly visits costs just under $7—a reasonable price for a two-hour session, less than what I would pay to see a movie or have a quick lunch. But there are those who will pay much more than I do for a session on the Stairmaster. Paradoxically perhaps, they aren’t the fitness freaks. The uncommitted couch potatoes pay the highest prices. That’s because they are paying for more than a workout. They are buying a commitment-booster too.

  A study of visitors to sports clubs that offered monthly subscriptions for just over seventy dollars or single passes for just over ten found that monthly subscribers paid more than they had to. They visited the gym 4.8 times per month, on average, paying some seventeen dollars per visit. Still, having a membership might improve their health, giving them a monetary incentive to work out.

  Every day we commit to buying goods and services without paying careful attention to their cost. In 2009, the HP DeskJet D2530 printer might have seemed a steal at $39.99. But the price, displayed prominently on the HP Web site, was almost irrelevant. The more relevant numbers were $14.99 for a black ink cartridge, which prints about 200 pages, and $19.99 for the color cartridge, which prints 165. For those printing photos at home, the crucial number was $21.99 for the HP 60 Photo Value Pack, a set of cartridges and 50 standard sheets of photo paper. At the Rite-Aid drugstore, 50 same-day prints cost $9.50.

  The worldwide printing business depends on selling cheap printers and expensive ink. According to a study by PC World, printers will issue out-of-ink warnings when the cartridge is still up to 40 percent full. HP, Epson, Canon, and others have sued providers of cheap ink refills, charging them with false advertising and patent infringement to make them stop. But the best ally of the printer business is consumer ignorance about what they are really paying to print.

  Just setting the printer default to “draft” quality would save consumers hundreds of dollars a year. Yet few consumers do. Though many companies still sell cheaper ink refills, refills account for only 10 to 15 percent of the market. That means that 90 percent of printing is still done using ink that, according to the PC World analysis, costs $4,731 per gallon. You might as well fill your ink cartridges with 1985 vintage Krug champagne.

  CONSUMERS CAN ALSO strategize keenly to fit their wants and needs to their budgets. As gas prices surged, drivers drove some 7 billion fewer miles on American highways in January 2009 than they did a year earlier, a decline of about twenty-two miles per person. During a run-up in gas prices between 2000 and 2005, economists at the University of California at Berkeley and Yale found that as the price of gas doubled from $1.50 to $3, families became more careful shoppers, paying between 5 and 11 percent less for each item. The typical price paid for a box of cereal at one large California grocery chain fell 5 percent. The share of fresh chicken bought on sale jumped by half.

  But businesses are usually a step ahead. Nobody understands for sure what drove surging prices of agricultural commodities in 2007 and 2008. Analysts have mentioned drought in important growing areas, rising transportation costs and fertilizer prices, the diversion of maize and other crops to produce fuel, and even improving diets in big developing countries like India and China. Whatever the reason, food companies were remarkably adept at protecting profit margins by quietly reducing the size of their portions while keeping the price the same. Wrigley’s took two sticks of gum out of its $1.09 pack of Juicy Fruits. Hershey’s shrank its chocolate bars. General Mills offered smaller Cheerios boxes.

  Then, as recession took hold in 2009 and agricultural prices started falling, firms resorted to the opposite tactic: giving consumers more for less and announcing it loudly. Frito-Lay packed 20 percent more Cheetos into each bag, stamping the bags with a “Hey! There’s 20 percent more free fun to share in here.” French’s tried competing against itself to convince customers it offered a killer deal. It launched a twenty-ounce bottle of its Classic Yellow mustard for $1.50, less than the $1.93 at which it sold its fourteen-ounce bottle.

  What really tames prices is the presence of more than one producer in the marketplace. If munchers had no other option but Frito-Lay products, the company would have less of an incentive to put more Cheetos into the bag and trumpet it to the world. Had there been no other confectioners around, Hershey’s might have raised the price of its chocolate bars even after shrinking them. But the price of a product must mesh within a universe populated by other brands of sweets and snacks. How well it fits will determine its overall success. This is consumers’ most significant defense against corporations’ power: competition.

  The power of competition is writ all over the cost of a phone call. In 1983, shortly after the government broke up AT&T’s monopoly of the American telephone market, AT&T charged $5.15 for a ten-minute trans
continental daytime call. By 1989 it charged $2.50 for the call. Today an AT&T subscriber on the $5-per-month international plan can call Beijing for eleven cents a minute and London for eight cents.

  In Britain, it was the government that held a monopoly over telecommunications. But in 1981 the government of Margaret Thatcher allowed Mercury Communications, a private company, to offer competing phone service, and in 1984 it spun off the state-run British Telecom. On February 1, 1982, the rate of a three-minute call from London to New York was cut from £2.13 to £1.49. Today, as long as one keeps each call at under an hour, BT’s international package offers an unlimited number of calls from London to New York for £4.99 per month.

  Competition can protect us from runaway printing prices. Fat profits from overpriced ink allow companies like HP to compete by selling printers at less than what it costs to make them. Others employ different tactics. Kodak’s ESP printers are about 30 percent more expensive than similar models, but the ink cartridges cost as little as ten dollars and print about three hundred pages. Regardless of the mix of tactics, the overall price of printing should fall as printer makers vie to win market share.

  CONSIDER WHAT HAPPENS when there is little or no competition in a market. Steve Blank, a former Silicon Valley entrepreneur who teaches a customer development class at the University of California at Berkeley, used to tell his students about Sandra Kurtzig, the founder of a company that in the 1970s designed the first business enterprise software for small companies that could run on microcomputers rather than huge mainframes.

  When she walked in to make her first sales pitch, Ms. Kurtzig had no idea of what to ask for her system, so she mentioned the biggest number she thought a rational person would pay: $75,000. But when the buyer wrote the number down without flinching, she realized she had made a mistake. “Per year,” she added quickly. The company man wrote that down too. Only when Ms. Kurtzig added maintenance at 25 percent per year did the buyer object, so she cut it to 15 percent. According to Mr. Blank, the company buyer said, “Okay.” Ms. Kurtzig could do this because she was offering a unique service in a specialized industry with few competitors, and thus had great freedom to set her prices. But where there are many rivals it is impossible to achieve this kind of market power. The mere threat of competition can move companies to respond. Indeed, for many years the threat that Southwest Airways would start flying on a given route would prompt other carriers to lower fares on that route, to preemptively buy customers’ loyalty.