When demand is greater than supply, the suppliers get to set the price. When supply is greater than demand, the demanders get to set the price. There are some limits, of course – an increase in price makes the demand go down, and a decrease in price makes the supply go down, so neither side can go crazy or they’ll lose their advantage. The end result of this is usually equilibrium – if the suppliers have the advantage, they’ll raise the price exactly to the point where raising it any more would give the demanders the advantage, and vice versa.
That’s the standard formula. But there are some weird things that can happen to that formula at the micro level, especially if the total number of players isn’t large enough for “The Aggregate” to start smoothing things out.
Imagine that there is a good that more than a few people want, and only one person has. This happens all the time – plenty of goods are unique, like art pieces or rare collectibles, etc. This one person has the ability to set pretty much any price they want, up to the point where the demand for the item at that price reaches zero. The profit-maximizing move is to set the price to the point where exactly the one person with the greatest desire for the item is willing to pay for it (and if you can figure it out, the maximum that person is willing to pay). But that’s not the only move, and certainly not the only move humans actually make.
Consider: Xander has a super-rare art piece, and Al, Betty, and Carl all want it. They’ve all expressed a desire for it, and they all know the other two desire it as well, but none of them (including Xander) know who wants it the most. So Xander sets up some sort of auction and lets them bid. In this way, they’ll reveal their relative levels of desire and Xander will get some new information. If Al wins the auction, Xander has discovered the point where Betty and Carl run out of desire, but not the maximum level of desire Al has. After all, Al might have bid a great deal more if Betty and Carl kept going!
So if Xander wants to raise the price even further he can try to, but Al now knows he’s the only buyer at this price or above. So he’s not incentivized to hand more money away – he knows if he walks away then Xander can’t get more money from Betty or Carl, and he knows Xander knows it too, so likely they’re going to settle on a price that looks very much like the winning bid.
But… let’s back up a minute. First, desire for an item doesn’t necessarily correlate perfectly with the ability to pay. Maybe Betty would have willingly paid twice as much as Al’s maximum price, but Al is much wealthier than Betty. This can kind of throw a wrench into things, for reasons we’ll see below.
Now, back to other “moves.” We’ve discussed how Xander can maximize his profit – but people care about things other than maximum revenue. What if Xander discovers that Betty wants the art piece because she is a dedicated art lover and superfan of the artist, and will display the piece at a local art gallery for the world to enjoy. Al, on the other hand, is an investor who doesn’t care about art at all – he intends to carefully store the piece, let it appreciate in value even further, and then resell it himself in the future. If Xander is an art aficionado himself, he may much prefer Betty to get the piece than Al.
But… let’s back up a minute again. Xander still needs money, or he wouldn’t be selling the piece at all. After all, he could display it in the gallery himself for the world to see. But he needs some liquid funds, for better or ill. So he’d rather let Betty have it – but if he says “I only want to sell it to Betty” then the price he’ll get is going to be way lower than the price he’ll get if Betty has to compete against other people.
What to do?
The thing for Xander to do is apply some conditions to the sale. You see, if you’re willing to forego a little of the control you have over the price, you can “buy” conditions on the sale. Xander could hold an auction for the art piece, but say “as part of the sale, you must sign a contract agreeing to store the piece in a local art gallery for the world to see for a period of at least ten years.” That’s going to lower his maximum price, both because he’ll be eliminating some potential buyers that don’t want to do that, and lowering the expected value of the piece even for the buyers still interested. But it will also satisfy one of Xander’s non-monetary desires, which is that the world be filled with art. He’ll get the maximum price he can within those conditions. Even if Betty is the ultimate winner, the fact that she has to bid against Carl means that Xander will get more than if he just said “I only want to sell to Betty.”
The more control over your price you forgo, the more control you have over conditions. As I said, Xander could forgo all price by just hanging it in the gallery himself – then he’d get to pick the gallery, how long it stayed, etc.
The same is true from the other side, by the way. If you’re the only one who wants a product and ten people have one to sell, you could just take the one who will part with it for the cheapest. But you can also see who will deliver it, who will gift-wrap it, and any number of other things.
The point here is to examine “price” as a concept beyond just the money that comes out of your pocket. As people exchange goods and services with each other, they also shift around the conditions under which we all operate. You’ll often be happier in your life if you look at those conditions, too.
The Opportunity Machine 