KOLKATA — Joe is an engineer and goes to work at 9 am in the morning. On the way, he grabs a Rs 200-coffee cup from a small coffee shop. As he hands over the amount to the cashier, he wonders why the coffee was priced Rs 200? Was this even a justified price that he paid for this cup? This is when Mr Henderson, his boss, stops his car at the signal and offers him a drop to the office.
They start conversing about the topic and Mr Henderson starts explaining. The price of the coffee cup does not merely include the price of the coffee beans or the milk in it but it combines the summated prices of all the intermediate goods, which together make up the final product, that is, the coffee cup which Joe picked up at the counter.
In addition to this, we should also consider the fact that the coffee shop sells hundreds of such coffee cups throughout the day along with few other products. For simplicity, let us consider that the shop only sells coffee.
Here is cost of production per coffee cup:
| Intermediate Goods | Cost (per unit) (in Rs) |
| Coffee beans | 40 |
| Milk | 20 |
| Rent of the shop | 50 |
| Logistics cost (to procure materials) | 20 |
| Staff | 15 |
| Electricity | 20 |
| Coffee machine | 10 |
| Coffee cup | 5 |
| Total cost of production | 175 |
Now, we see why that is the cost of producing an individual coffee cup.
Joe thinks, “Hmm. Well, I finally understand the cost of production of the coffee cup, but wait, it adds up to only Rs 175, whereas, I got it for Rs 200!”
Mr Henderson smiled and said, “What drives the enthusiasm of the coffee shop owner to make sure that his shop is open every day?”
Joe exclaims, “Profit!”
Mr Henderson replied, “Clever boy! Profit fuels the spirit for business to operate daily, throughout the globe.”
So now, here is the unit economics behind the cup of coffee:
| Intermediate Goods | Cost (per unit) (in Rs) |
| Coffee beans | 40 |
| Milk | 20 |
| Rent of the shop | 50 |
| Logistics cost (to procure materials) | 20 |
| Staff | 15 |
| Electricity | 20 |
| Coffee machine | 10 |
| Coffee cup | 5 |
| Total cost of production | 175 |
| Markup | 25 |
| Total Price (Sale Price) | 200 |
By now, Mr Henderson assumed that Joe was satisfied with his answers as he was looking content by having ‘justified’ his cup of coffee for Rs 200. All of a sudden, Joe spoke, “Mr Henderson, tell me one thing, why does this same cup of coffee cost me Rs 100 at the stall put outside the bandstand at North Park?”
“Hmm, interesting question. Now, let us understand why the same cup of coffee varies in price at different places.”, said Mr Henderson.
Why are same goods priced differently at different places?
Even if we assume for the sake of simplicity, the quality and quantity being offered is constant everywhere, which practically is not, we can present a few factors which contribute to the phenomenon of the same goods being priced differently at different places as:
- Remote locations: Places such as hills and mountains may demand premiums on the prices of products such as coffee due to the high prices of procurement of materials or high prices of logistics. Due to the low temperature, people prefer having hot beverages and if the supply of the relevant product is scarce, then it often inflates the prices for the same.
- At a mall: Places such as malls often demand a higher pricing for products (say Rs 350 for the same cup of coffee) due to high rents of stores, the purchasing power of the customers who usually shop there and high operating expenses which would otherwise would not have been so much if the same coffee shop was to be established at a local bazaar.
- At the food truck: A food truck may not demand prices ‘pari passu’ to the small coffee shop or the mall as it does not have to pay rent but may incur a handsome parking fee for a limited duration depending on the location where it is parked. It may also incur fuel expenses but its operating expenses may be lower than that of the other two discussed earlier. Therefore, the same cup of coffee may cost Rs 100 there.
In addition to this, as we dive into complexities, there are other multifarious factors which contribute to the different pricing of the same goods at different places.
#uniteconomics #economics #intermediategoods #production #costofproduction