The Economy: 11. Pricing and Discounting

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Welcome to Understand the Economy, the podcast that takes you back to basics to explain, explore, unpick, and elaborate on how economics affects our everyday lives.

I'm Felicity Hanna.

I'm a business and personal finance journalist.

So I am fascinated by how those big financial concepts roll out across the economy and have a direct impact on companies and on households.

And so far, this series has looked at a lot of those economic issues, from interest rates to bonds and inflation to recessions.

And you can listen to them all right now on BBC Sounds.

Today, we're taking a look at one of the most basic but important ways ways that we interact with the economy, the price we pay when we buy stuff.

We've all noticed that things are getting more expensive, whether it's fuel for the car or butter for our toast, and especially if you like to butter your toast as thickly as I do.

And prices have been rising at a record rate.

But even as prices rise across the board, retailers are still promising discounts, bargains, and sales.

So in this episode, we're going to demystify how prices work, try to understand how prices are set, and figure out who actually has the power in the buyer-seller relationship.

And to help us make sense of it all, I'm joined by Rupel Patel, economist at the Bank of England and co-author of Can't We Just Print More Money?

Economics in 10 Simple Questions.

Rupel, hello.

Hello.

Thank you for joining us.

Let's start with the basics.

What is a price?

So a price is the amount that a business will charge for something, and it has to be a price which people are willing to pay.

So how do businesses decide how much they're actually going to charge?

So businesses firstly have to make sure that they cover their costs of selling something.

And costs depend on loads of things.

So it can be the price of the electricity bill, the price of hiring staff, or the price of actually buying that thing in the first place from suppliers.

And so they usually set a price which is just above the cost price to make sure that they can make enough profit to stay in business.

Okay, let's say that I make a product.

Maybe I make, I don't know, a teddy bear that burps, which is clearly going to be a Christmas must-have toy.

Now, if I sell those to toy shops for a lower price and they sell it for a higher price, that's known as the markup.

Do I, the manufacturer, tell the shops how much they can charge for a burping bear?

No, it's usually up to the business themselves to determine how much they want to set the price at.

And if you think it's a Christmas bestseller, you might put up the price as a business as we get towards Christmas.

And you might have to lower it or put it on sale in January when fewer people want it.

But as a manufacturer, I might sell some bears directly to the public.

So then I've got two different prices.

So when the manufacturer sells to the public, they're probably selling it in smaller quantities than when they do to businesses.

Businesses usually buy in larger quantities than an individual like you and I, and they're able to offer discounts on those teddy bears.

We will talk about buying in quantities in just a moment, but overall then, you talked there about prices being potentially raised in December just before Christmas and then dropped in January when everyone's done their Christmas shopping.

When it comes to retail prices then, is it just about supply and demand?

Yes, when there's a lot of demand for something, businesses can charge a lot more.

And when there are fewer alternatives available, there's only one of something, they can also charge a lot more.

Now, a really good example of this is a pick and mix bag, which was sold by a store manager who used to work in Woolworths.

It was actually the last Woolworths Pick and Mix bag to ever be sold.

Of course Woolworths was a high street store, sold lots and lots of different stuff including pick and mix, went out of business in 2009.

Yes and in that same year this bag of pick and mix sold for £14,500.

£14,500 for a bag of pick and mix?

Yes, a ridiculous price to pay.

That's going to make me feel better about the next time I go to the cinema and buy a bag of sweets there.

Why would anyone be willing to pay that much for something that would have cost them a couple of quid the day before?

It's because there was only one bag available.

All the Woolworth shops had closed down and so people knew they wouldn't be able to buy a bag of Pickamix from a Woolworth ever again.

That is some very, very expensive nostalgia.

And we should say that store manager might have sold that bag of Pickamix for £14,500,

but they did give the money to charity.

Okay, so it's really simple, isn't it?

You're willing to pay a lot more if you really want something.

Yes, it's what economists would call utility.

So utility can mean lots of different things for different people.

And it's not just to do with pricing, but the more utility that people get out of something, the more they might be willing to pay for it.

So does that just mean usefulness?

It can do, but it can also mean just things that bring you happiness or joy.

So for me, coffee brings me a lot of utility.

So if I've had a late night and I'm quite tired, I might be willing to pay more for coffee as it will bring me more utility than on some other days.

Now I'm thinking of ways shoppers can bring down prices.

So buying in bulk is one way.

It's more expensive up front, but then it means each toilet roll or kilogram of rice is actually cheaper.

Yes, buying in bulk benefits both the buyer and the seller.

So for the seller it guarantees that someone will buy more than they usually would have.

For the buyer per unit it's a lot cheaper.

A good example of this are actually gym memberships as at the beginning of the year a lot of gyms offer discounts on annual memberships.

And this is because they know that a lot of people would stop going to the gym perhaps after three months if they only had to pay month by month.

So, as a gym goer, per month you're paying less.

But as the gym, it costs you no more to provide access to your gym for three months versus 12 months.

And because you've locked in someone into paying upfront 12 months for a membership, you've earned more money from them, even if they stop going after three months.

So, regular gym goers shouldn't complain about the January crowds.

They're actually subsidising the rest of their membership.

No, it's a very good bargain for them.

Let's go back to my burping bears, because I am convinced this is going to take off.

Say they're really popular toys, and I ramp up the price.

That doesn't actually cause too much of an issue, does it?

Because no one actually needs a novelty bear.

What about when we can't afford the full price for everyday necessities?

Here is our resident economic historian, Dr.

Victoria Bateman from the University University of Cambridge, with an example of people struggling with exactly that.

In 1844, at the height of the Industrial Revolution, in Rochdale, a northern town full of cotton mills,

a group of weavers struggling with the cost of living hatched a plan.

They pulled together their grocery money so that they could bulk by their everyday necessities.

things like butter, flour, sugar, oats and candles.

By buying in large rather than small quantities and by going direct to producers rather than buying from local shopkeepers, they were able to source their groceries at knockdown prices.

Other mill workers wanted a piece of the action, and by paying a small fee they could become members of this group of weavers.

So the group were known at the time as the Rochdale Society of Equitable Pioneers, and they're what we could think of as being the first successful cooperative in English history, really.

And they went on to inspire similar cooperatives up and down the country.

But, you know, it was really in the north of England that this cooperative movement took off to the point that in 1863 they decided to join together, they formed the Cooperative Wholesale Society, and later became known as the Co-op.

Okay, Ripple Patel, that is an example of bulk buying that benefits the buyer.

But unlike that gym membership example you gave, it doesn't lock anybody into any longer-term sales.

How does that benefit the seller?

It benefits the seller as by dropping the price, they know that more people will come and buy their goods or buy more of them.

So a good example of this, a sale that I'm sure a lot of us have taken part in, which are happy hours.

Never

taken part in a happy hour.

Never taken part.

And during happy hour, people buy more drinks than they usually would have, particularly, you know, just five minutes before the end of happy hour.

And this helps the bar because they sell more drinks than they usually would have.

And they make a lot more sales.

So much so that actually around 60% of bars' alcohol sales come from happy hour periods.

Okay, I suppose then that applies to sales, doesn't it?

If I see a new dress in the sale, I might be tempted to buy it because the price is reduced.

Whereas I might have saved the money and not bought it at all if I hadn't seen it in the sale.

Yes, sales do make us buy more than we usually would have.

But it also means that you might buy more things that aren't on sale.

You might walk into a shop and see that dress and think, oh, it's so cheap, I'll buy it.

But then you might look around at the non-sale items and find other things that you would have wanted to buy.

And businesses can make even more money.

Oh, that's very interesting because we've we've all seen piles of discounted stuff, discounted goods and products at the front of a supermarket.

So, sellers have a reason to reduce prices beyond just shifting that stock.

Yes, sometimes actually, they don't even reduce the price, they offer things for free.

So, TV subscription services sometimes offer free weekly trials in the hope that perhaps maybe you'll get really into a TV show and end up paying for a few months more of that subscription.

And that way, the service actually makes quite a bit of money off you.

Oh okay so buyers have to be a bit savvy.

They have to look at a price and wonder why am I being offered this good or this service at that price.

Okay we also see prices going up and down.

Prices go up and down depending on how much people want them or how much of it is available.

And that is why when I book a taxi ride on a Friday night it's more expensive than say on a Monday morning.

Yes, exactly.

Lots of people are out in Waus on a Friday night than they are on a Monday morning and so taxi companies can charge more for the same journey.

How much power do we as consumers have to affect prices?

Consumers can have a lot of power, or what economists would call bargaining power, but it depends on the product.

If there's lots of alternatives available, businesses have to compete to get your business and so will have to drop their prices.

But if there isn't that much availability and only one business is selling that thing, they have a lot more power.

So burping bears, the price will be undermined if belching bears also come onto the market at the same time.

Yes, definitely.

Tell me about surge pricing.

What's surge pricing?

Surge pricing is when there are a lot of people wanting the same thing at the same time.

And if they're desperate for it, they'll be willing to pay a lot more.

So going back to the taxi example, on a Friday night, say it's 11.30 and public transport is about to close down, there's no other way of getting home, taxi companies can put their prices right up because there are no other alternatives available.

How does pricing work when there's high inflation?

So, inflation is the rate at which prices change across the economy.

And when prices go up, consumers do change their behaviour.

They want less of something because it gets more expensive.

And so, businesses might put their prices down.

But we have to remember that businesses are also affected by inflation.

And in particular, the inflation we're seeing now in the economy is largely driven by an increase in energy prices.

And those energy prices really hit businesses quite hard, as energy prices are a big factor of their costs.

And so businesses can only drop their prices to a certain extent, but they still need to maintain profits.

How do prices affect the wider economy?

What do you think about when you're walking around your local supermarket?

So prices are really important as they set how much you can buy with your disposable income.

So if prices across the economy are going up, you can buy fewer things with the same amount of disposable income.

And if they're going down, you can have more things.

And so it's quite important how much prices go up or how much prices go down.

RuPaul Patel, economist at the Bank of England, co-author of Can't We Just Print More Money?

Economics in 10 Simple Questions.

Thank you so much.

So there you have it.

Penny Suites are worth pennies unless they're suddenly incredibly rare and then they can sell for thousands.

And all sorts of different economic factors can dictate prices, from energy costs to supply chains.

Ultimately, though, whatever a retailer is selling is really only worth what someone's actually willing to pay.

Next time, what happens when we're willing to pay more than we actually have?

That's when we turn to credit.

So, how does that work, and what does it mean for our nation's finances?

You can wait for the next episode, or you can binge it all now like a bag of pick and mix on BBC Sounds.

Understand the Economy was presented by me, Felicity Hanna, produced by Louise Clark Robotham.

The researcher is Beth Ashmead Latham, and the editor is Claire Fordham.

It was mixed by Nikki Evans.

Hello, it's Chris Van Tulliken here.

My brother Zond.

That's me.

I'm here too.

And I are back.

Now, in series two of our Radio 4 podcast, A Thorough Examination, we are on a mission to find out whether or not people can change.

It's called, Can I Change?

We're thinking about all the things we want to change about ourselves and each other.

Wait, what?

I want to be more confident.

I'd like to be less of a people pleaser.

I'd like to be more of an extrovert, but then sometimes I also think I should shut up.

A quiet, confident man.

That's very attractive.

Yeah, I'd like a quiet confidence.

I think everyone has something they'd like to change about themselves.

Change is important to me because I think it's going to improve the key relationships in my life and one of those is you, Zand.

You can change whatever you like, just don't make me do it again.

Well nonetheless, Zond, we are going to speak to some experts who are going to guide us through the idea of change.

The last time you made me do this, it changed my life for the better.

Yeah, but I still don't want to do it.

And if you at home think there's something stuck in your life that needs changing, this might be helpful for you too.

Search for a thorough examination with Doctors Chris and Arn on BBC Sounds.

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