The difference between a cost and a price

Let’s start this series with a fundamental question on the economic approach:

Why is there a difference between a cost and a price ?

Understanding the difference between a cost and a price is key in understanding economics. As we look at people, economists pay attention to everyone’s perspective – even when they’re aggregated in groups. Different people, different perspectives, different values.

TL;DR

Prices are an indicator

The price is the number showed on a good’s price tag. It’s the amount of money both the seller and buyer agree on to exchange the good or service.

Let’s take Africafé, a can of instant coffee. It is usually priced at $4 in Uganda. If it’s almost expired, it can go on sale for $2.

The price is an indicator of willingness to buy and sell. In a set context, it gives you a wealth of information on someone’s preferences, lifestyle, social status and environment. It tells you simply what someone is ready to trade off for this purchase. And vice-versa with the seller: what they are gaining by trading off this good.

And it’s a beautiful indicator, because it shows the truth about someone’s preferences. When a purchase occurs, both buyer and seller walk the talk. Someone can brag all they want on how coffee is indispensable for them, if they don’t buy it, I don’t buy it.

At a public health happy hour, someone told me they like organic food because of the smaller environmental footprint we leave when we consume. The happy hour had a 2-for-1 deal on Bud Lights (popular American beer, not organic). There was an organic option at regular price (more than for one Bud Light, naturally), but she purchased the Bud Lights. So, where’s the truth – in discourse or in actual behavior?

 

Costs have a perspective

The cost is the amount of resources that it takes to produce or purchase (depending on the perspective) a good or service.

While the price is the amount exchanged between the seller and the buyer, it does not, directly at least, represent what was needed to produce it.

For instance, it may only take a few cents to produce and deliver a can of Africafé to the shop where I bought it (its cost of production). Yet, I bought it for about $4 (its price). And it took me a bit of gasoline and time to that shop by car, which cost me an extra few cents (a cost associated with acquisition of that good).

Note that we have one price, and two costs: one for each perspective: mine (the buyer) and the seller’s.

Technology, the cost of inputs (they each also have a price which connects a buyer and a seller), workers’ salary, transportation costs all contribute to the cost of production. Sellers make a profit by selling a good above its total cost of production. Better technology and cheaper inputs make production cheaper, but do not directly affect the price. It may indirectly when it changes the overall supply of the good – in particular if other suppliers bet into this product’s market.

Getting transportation and the time spent to get to the shop contribute to the cost of acquisition. It took me 5 minutes and a quick stop on my way back home to purchase this coffee. I may not have purchased it if it wasn’t already on my way home (meaning a higher cost for me).

This latter cost is particularly important when assessing people’s access to healthcare and education. How far someone has to go to take their child to a hospital or a school can be a determinant of this child’s health and school attendance. This is the core idea of the cost-of-illness study we are leading in Uganda and Bangladesh.

 

TL;DR

The difference between a cost and a price: costs have a perspective, prices do not.

The price is the amount of money the seller and the buyer agree on for a good or service.

The cost is the amount of resources needed to get a good or service:

• cost of production for the seller
• cost of acquisition for the buyer
• transaction costs borne by society as externalities (discussed in another post)

If you see two similar goods or services at different prices, it does not mean that one was more expensive to make than the other. And if nobody buys the more expensive good, it means that it isn’t worth more than the other (it may mean the opposite).