That Evil Selling Below Cost

In their textbook, Pete and Dave have a terrific section discussing the argument that "selling below cost" is a bad thing that we should try to prevent.  The core of their argument boils down to "what cost, and to whom?"  (I should note that those two questions are a running theme of the entire book.)  There's a nice series of examples involving a grocer who buys bananas and then has to decide how best to get rid of them as they begin to spoil.  They point out that if one considers the positive cost of disposal, giving the bananas away might be the best choice for the grocer, which, of course, is "selling below cost."

In any case, I now provide them with another example.  A local furniture store here in Canton has a section of their space devoted to selling greeting cards (see:  Smith, A on the division of labor and the extent of the market).  Evidently that's turned out to be a losing proposition.  I went by the store the other day to get a graduation card for my step-niece and saw that the shelves were only half-full and that they were advertising "Hallmark Cards 10 for $1."  I can assure you that 10 cents per card was selling way below cost, if cost referred to what they paid for those cards long ago. 

But if cost is really marginal opportunity cost, 10 cents per card to dump their inventory, in the face of the long-sunk costs of acquisition and avoiding the costs of disposal, looks very different.  And it certainly benefited THIS consumer!

Comments

[Greg Ransom]

A garage sale is largely an opportunity to find people to haul away your stuff for free -- we were disappointed when a couple failed to come pick up the couch they'd bought ..

[Steve Horwitz]

One of the strange and wonderful things about living in this particular area is that you can put stuff you don't want out at the bottom of your driveway and almost always within 48 hours, it will be taken. What's interesting too is that all such acts come with the tacitly agreed upon norm of "as is." I got rid of an old grill that way a couple of weeks ago.

[Current]

What worries leftists about this is the power it gives bigger businesses.

They say that a big business can come into an area and sell below cost for many years. All the smaller businesses in the area don't have enough capital to compete. So, the smaller businesses go bankrupt. Then the big business has a local monopoly afterwards. Hence the amount of capital a business has determines its long term success.

I've never actually seen this happen. I think that one answer to why lies in entrepreneurship and another in the natural rate of interest. Most folks here can probably understand what is wrong straight away. However, I've never read a good reply presented in a book or article.

[Steve Horwitz]

See the aforementioned section in "The Economic Way of Thinking".

[Dave Prychitko]

Current: Look up (Google) John McGee's 1958 article.

[Current]

Thanks.

[Jodi Beggs]

I think it's important to remember that free disposal is very often an unrealistic assumption. Furthermore, I would argue that there is a difference between explicitly planning to sell below cost and resorting to selling below cost due to unforeseen circumstances. In the latter scenario, the cost itself is usually a sunk cost, since once you've (you being a retailer) purchased the merchandise you often can't return it, at least not for a full refund. As economists are quick to point out, sunk costs should not factor into decisions, since they are there regardless of what choice is made. In fact, it is these sunk costs that cause anchoring effects that are economically inefficient, such as someone unwilling to sell a house for less than they paid for it.

The scenarios in the comments remind me of the time one of my friends needed to sell his car- he said that he would sell to the person not necessarily with the best offer price but the one who could make taking the car off of his hands as little work for him as possible. :)

[Dave Prychitko]

And here's another way to interpret it. The relevant cost is now the cost of retaining a good. So suppose Weiser paid $500 for good X and would consider selling it. In fact, let's assume he'd be willing to sell X for $200.

Smith offers $250 while Marx offers $300. He now has indicators of the cost of continuing to own X. If he sells it to Marx, what is Weiser's cost of relinguishing ownership?

$250, the cash he can get from Smith, the next highest bidder. While someone might argue that Weiser sold it "below cost" -- looking only at his cost of acquiring X ($500) -- I would argue that it is $250, so he actually sold it above cost.

The same, though more complicated, can be true of a producer. While some might claim that the "real cost" of producing good Y is, say, $10,000, the relevant cost is now one of retaining ownership, and that is determined by the bids that others make in the market.

[Dave Prychitko]

Note I asked what is the cost of relinquishing ownership (I accidently jumped to a new question above). What, on the other hand, is Weiser's cost of *retaining* ownership? Well, if he can get the highest bid of $300 from Marx, and continues instead to hold good X, then he sacrifices the opportunity to enjoy $300. From this perspective, if he sells to Marx he is selling at cost of retaining ownership.

So we have two situations from Weiser's perspective. Cost to still own: $300. Cost to sell to Marx: $250.

Which is the so-called "true" cost. That cannot be answered. "Cost" only makes sense in the context of actions and opportunities. Cost of doing what? Cost to whom? Anyone who discusses "Selling below cost" fails to recognize the relevant choice context.

[Dave Prychitko]

And one more consideration. There is also Weiser's cost of using good X. To simplify, suppose to maintain good X he incurs $20 a week. Then the cost of using good X is $20 per week, and that of course represents $20 of other goods and services he could enjoy should he continue to use good X.

Then, although we have a simplified setting of Wieser's opportunities, it makes my case even stronger. There is no "the cost" to Weiser. Cost of doing *what*? Of using, of continuing to own, of selling X to one bidder over another, of considering giving it as a gift to a loved one or to a charity, of burning the good, of storing the good, and so on?

We can go on and on, but we are not playing games here. Cost only makes sense in the context of an individual's relevant actions and opportunities.

[Dan]

Your example is exactly the same as the banana one, there is no "evil" if you lose money on the transaction but gain some benefit...(in this case getting rid of inventory, and at least getting something). It is "evil" if you do it and MAKE money!! It just means you are getting a subsidy somewhere or there are some externality you are exploiting.
The same for a business carrying a unit through subsidization continuously, the only units you can carry is those that is essential or make the business more efficient like the IT department, mail room etc. In effect everything have to pay their own way and make money.