What Determines Value and Cost (Part 1)

(Consumer Safety & Awareness article: Part 43)

What is Value?

Technically, something is valued if it is needed, wanted, or generates special memories. When we refer to an economic value, though, we are looking at a product we want at a price that is less than we expect to pay. Generally the only way we have to know if a thing is truly on sale is if we make it ourself, believe the store that is selling it, have compared the price of that product at many other locations, or know how much it costs the store to purchase it (wholesale).

In a blanket statement, although one that does not always apply, consumer economists suggest that you never believe a “list price,” an advertised rate, or a store sign as an indication of the true value of the product.

Thus to know if something is a good bargain, the consumer must know how much it costs to produce. The true cost can be determined in two ways. One is the Supply and Demand method and the other is an actual calculation of all the factors that goes in to creating the product, bringing it to the store, and making it available for you to purchase. Few people know what those factors are. This week we will look at a few of them, and conclude in the next article.

1. Raw Material. All products originally come from natural resources. Be it grown, mined, harvested, artificially altered, or chopped down, the cost of removing the raw material from its original source can vary. This is where Supply and Demand has the most influence. If the product contains a rare material, and many people want it, the cost of production may be elevated.

We see changes in raw material prices frequently as a food item’s availability is affected by storms, drought, blight, or other “act of God.” A frost in Florida may reduce the amount of oranges available, and thus increase the cost of production. The farmers still have to pay for the care of the trees, taxes, fertilization, pest control, etc., for their orchard. They have fixed costs, yet may be getting a fraction of their normal crop production. Prices go up so that they can stay in business.

Another fixed cost of raw material is the search for new sources of the item. One reason oil production is expensive is due to the need to constantly search for new fields. They may be under the ocean, in hard-to-access locations, or in populated regions. The cost of geological surveys, land leases, the moving of equipment, and many other factors all add to the cost of the product. Even if the new oil wells are unproductive, the expense of drilling has to be passed on to the consumer or the company cannot stay in business.

2. The Human Factor. Ineptness, power, and greed play a huge role in the cost of an item. When a petroleum transport goes aground and spills oil into the ocean, the company has to pay for the repair and replacement of the ship, the clean up, any fines, as well as the cost of the lost product. The expense of such actions is passed on to the consumer.

International policy also affects how much a product costs. When the United States placed a boycott on products from Iran in the 1980s, we lost our main source of pistachios. Prices tripled in less than a year. The increased prices reduced demand. Eventually pistachio farms were developed in California and elsewhere, increasing the supply and thus lowering the cost.

Throughout recent history, petroleum has been used as a power-pawn. OPEC artificially reduces production in an effort to: a) obtain more money for member nations; b) increase their international power and importance; c) use as a hammer to force through policies that are beneficial to them. Hugo Chevez used Venezuela's oil production as a propaganda tool, offering discounted prices to America’s poor in order to win friends.

In 1980, Nelson Bunker Hunt and William Herbert Hunt, together with some wealthy Arabs, controlled the supply of silver in an attempt to gain extra profit. Silver had been selling for under $2 an ounce in 1973 when their scheme started. By 1979 their manipulations increased the cost to over $5 an ounce, and they were not satisfied. These people purchased more than half the world’s supply of silver and withdrew it from availability, causing prices to skyrocket. At its peak in early 1980, silver was going for $54 an ounce. Once the Federal Government stepped in, the prices collapsed falling 80% in less than a month.

3. Currency Exchange Rate. The price of most products float – they are unrelated to the value of a specific currency. Petroleum and other commodities are tied in to the value of the American dollar. With political, economic, and other factors constantly changing the value of currency, the costs of products related to them vary as well. The current high cost of petroleum and oil products is in part due to the lower value of the American dollar as compared to other currencies.

Exchange rates can have both positive and negative effects. A lower American dollar means that products produced in this country cost less overseas and thus sell better. This lowers our trade deficit and helps multinational companies. Products produced elsewhere, though, such as cocoa, bananas, electronics, European wine, and raw material, cost more in the United States.

Next week we will look at transportation, insurance, and fees that add to the cost of a product.