value, price, and cost

["John S. Denker" <jsd@MONMOUTH.COM>]

At 04:26 PM 10/5/99 -0400, Hugh Haskell wrote, speaking of pearls:
> Their beauty derives mostly from how hard it is to get them.

That mostly misses the point.  Many people would consider pearls beautiful
even if they were easy to get.

> the price is more dependent on rarity than beauty

Actually the PRICE depends both on rarity and beauty in complicated ways as
discussed below.

> If one
> could pick them off the beach like sand, they would have virtually no
> value no matter how beautiful we consider them.

I'm pretty sure I agree with the sentiment expressed there, but to be
precise it would have been better to word it differently, such as:

% If one
% could pick them off the beach like sand, they would have a very low
% COST and a very low PRICE no matter how beautiful we consider them.

Note that there are three concepts in play here:  The VALUE to the
end-user, the COST as seen by the pearl-diver, and the PRICE (i.e. market
price) which is presumably somewhere in between.

The situation is illustrated in this figure:
  http://www.monmouth.com/~jsd/physics/value-cost.gif

where the X-axis represents the total volume of goods produced.  It is the
*slope* of the cost curve that represents the cost per unit.  Similarly it
is the slope of the value curve the represents the value per unit.  In the
upper panel we see that the initial slope of the water-value curve is very
very high.  Water is tremendously valuable if you don't have very much.
OTOH if you have plenty of water, you find low-value uses for the
additional water.  In this simplified model, let's assume the water-cost
curve has constant slope (constant cost per unit).  It becomes uneconomical
to produce additional water when the unit cost of production exceeds the
unit cost.  This point is indicated by tick-marks on the graph.

The thin dark line tangent to the value curve is parallel to the cost
curve, to help you identify the point where the slopes are equal.

As a general rule, the per-unit price (i.e. market price) of the goods lies
somewhere above the per-unit cost (otherwise the producer wouldn't want to
sell) and somewhere below the per-unit value (otherwise the customer
wouldn't want to buy). At the endpoint, we have a three-way equality:
        unit cost = unit price = unit value
but this equality does not in general apply to anything except the sale of
the last unit (the "marginal" unit).

======================

As for pearls, there are some high-value applications (e.g. jewelry) and we
can certainly invent low-value applications (we could grind them up and
sprinkle them on the lawn to combat acid rain).  This is shown in the lower
panel of the figure.  The value curve has qualitatively the same shape as
in the upper panel, although the X-axis must be rescaled to represent
different units.

The difference in the lower panel is the cost of production.  The curve is
much steeper.  The high cost guarantees that the price of pearls will be
high.  Changing the cost would change the price, but it would not change
the value OF ANY PARTICULAR APPLICATION.

=====================

Economics is a fairly tricky subject.  This is not the place to go into the
details.  But please keep in mind that there is an important distinction
between value, price, and cost.

______________________________________________________________
copyright (C) 1999 John S. Denker             jsd@monmouth.com