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EconNic

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Response to 'Dirtier by the dozen'

04 October 2012, 08:25

Recently, a fellow author on this forum wrote an article about the difference in price between a single carton of long-life milk and its six-pack counterpart. In the article, the author made the case for why supermarkets are evil organisations secretly (or at least, not obviously) forcing us to pay extra for the subdivided six-pack of milk. Later, many users commenting on the article expressed agreement.

As with many incorrect views, this one generates broad appeal. The allusion to the basic maths necessary to calculate the ‘fair’ price of milk, and simple logic therein, adds to this appeal. Yet, the author, as many others before, has made a grave error in ignoring the other side of the story; cue the economic sciences.

The biggest problem with the author’s analysis, and one which must be clarified before proceeding, is the lack of distinction between a single carton of milk, and a six-pack of milk cartons. While, superficially, these are composed of the ‘same’ goods, they are, in fact, distinct, separate items. As such, any economic activity relating to these two goods must be treated as such, that is, separately.

This, of course, brings us to the question: why (in relative terms) does a single, separate carton of milk cost more than the single carton of milk in a six-pack? The factors affecting its price, such as supply and demand (a related market term is ‘fundamentals’), differ between the individual carton and the six-pack.

The author keenly points out that they habitually buy the six-packs of milk, and expresses frustration at the lack of availability of this product (which, let us remember, is different from the individual carton). However, what they fail to see is that, as mentioned, a single carton of milk is not the same thing as one sixth of a six-pack in economic terms; these are two entirely different products, as mentioned.

Basically, the relative higher price of the individual carton is a signal; an effect. It shows that the majority of customers prefer individual milk cartons, that is, there is greater ‘demand’ for these items. As in a natural market system, a greater demand for an item (all other things equal) results in an increase in price. The relative higher price tells us that, by far, consumer preference is for individual milk cartons. Implicitly, the relative lower price of six-packs incentivises customers to buy these goods. This principle is applicable with special discounts on goods as well. Furthermore, even when such incentives exist, it may not be enough to ‘clear the market’ or generate enough demand to justify keeping a large stock of these cheaper items, such as the six-packs of milk. This is why the author has such trouble finding their beloved six-packs on the shelves – because his fellow customers, in the outright majority, prefer individual milk cartons.

Even if you do not agree with the former economic analysis, then another fundamental question remains: if it is so inconvenient, why does one still choose to pay these prices? Except in the case of government-enforced monopolies (Eskom, SARB and others), everyone engages in voluntary exchange. In other words, one chooses to go to a supermarket and pay a ‘ridiculous’ price for milk.

The alternative is driving some distance to a dairy farm and reaching an agreement with a farmer for some of their milk, or, as some suggest, buying a cow. The difference, of course, is that a lot more of your time and effort will go into obtaining milk. This is exactly why supermarkets get to charge ‘up to three times’ the price at which they buy milk from the farmer; the supermarkets or producers accept the responsibility of engaging the necessary labour and in the entrepreneurial risk of selling the product, and thus calculate their prices accordingly. Recently, a user commenting on the original article noted that much of the process is automated and does not justify the price of milk. This user has ignored the cost of capital needed to automate these processes, which is undoubtedly priced in to the product.

If nothing else, the main lesson, in my view, to be taken from this is that supermarkets are not evil oligarchies. Rather, they choose to serve the majority of customers in the manner which most of the customers find to be most convenient. This is democracy, but of a different sort: it is the democracy of the market.

Just out of interest: much of the comments section of the original article has been dominated by prices. In terms of individual goods, prices are the result of many factors, but for those interested in why prices rise perpetually, it is not the fault of supermarkets and schemes (at least on their part). If you want to learn more, read my previous article entitled So what is inflation really?.

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