Today I was listening to the most recent Econtalk podcast and I had a eureka moment. Russ Roberts and his guest, Robert Frank, author of The Economic Naturalist, were talking about why brown eggs are more expensive than white eggs.
In thinking about prices up until now, I had always thought namely about static supply and demand. There is a static supply, as in an auction, and the bidders determine the price. This conversation pointed out the importance of the cost side of the equation. I have always been suspicious of cost-based justifications for price rises. "The price of jet fuel is higher now, so we have to raise the price of airline tickets." Such an explanation ignores the demand side, and the only way the airlines could make the price rise stick is if people kept on buying airline tickets at the new, higher price.
In the brown eggs example, with my prior understanding, I would have said, "Some people say value of the “natural” appearance of brown eggs (even though they taste the same and have the same nutritional value as white eggs), and therefore are willing to pay a higher price. But what this analysis lacks is a focus on the supply side. Over time, why do farmers not produce more brown eggs, thus bringing the price down to equal that of white eggs? The answer is, according to Robert Frank, that brown eggs are more expensive to produce. Hens that lay brown eggs tend to be larger and require more food than hens that lay white eggs. Because of the higher cost of production, farmers do not see increased profit from selling brown eggs. Therefore the supply does not increase, and the price does not go down.
