Price vs Cost

PRICE is the amount of money expected in a trade of goods or services.  For example, if you bought one pen for $5, this is the price of the pen.

COST is the amount of money incurred in producing and maintaining a good or service. For example, if one company produces pens, they need ink, plastic, pay the labor, among other expenses. All these expenses combined with these materials, services, and overheads are the cost of the pen in the company.  

Let´s see the differences in more detail:

Price

The formation of price is normally not so a straightforward process as it depends on multiple factors such as supply and demand, risks, margins, commissions, and more. In the end, the price is the amount of money that a customer is willing to pay for a particular product or service.

Factors that drive a variation in price:

Price is a dynamic element that can change over time to accommodate various circumstances.

Finding the right price is a difficult and complex task, as setting the price too high may lead to a decreased sales derivative to a reduction of customers’ demand. As a result, the customers may seek cheaper alternatives or try to find substitute products or services with similar characteristics, for example instead to buy a pen the client decides to buy a pencil.  

Supply and demand have opposing interests, meaning that an increase in price causes the supply to maximize profits while the demand side seeks to minimize the price to reduce costs.

Factors Influencing Price:

Several factors can cause a deviation in price, such as the number of competitors in a specific country or region, seasonal fluctuations in demand, and more. For example, the price of pens may increase in a country with few competitors compared to a country with multiple suppliers or retailers. Additionally, the demand for pens may increase at the beginning of the school year, leading to an increase in price by the supplier.

Profit

Profit is the extra money earned when the price of a product or service is higher than its cost. For example, if a company sold a pen for $5 but only incurred a cost of $3 to produce it, it would have a profit of $2.

Price = Profit* + Cost (materials, services, and overheads)

 *It´s possible to sell a product or service with a loss, but this is not common.

Price classification

Prices can vary during a negotiation, and these different prices are given different names. A few examples include:

-Initial ask price – The price the seller asks for.

-Bid price:  The price the customer is willing to pay.

-Transaction price: The price both parties agree to and are willing to transact at.

For instance, the company may have an initial asking price of $13 per pen ($10 profit + $3 cost), but if the customer only offers $5, the bid price would be $5. The price that the company and the customer agree to do the deal at is the transaction price. In this example, the initial asking price was $13, but the transaction price was $5, meaning the seller had to make a substantial discount from their initial asking price in order to sell the product. This demonstrates price elasticity – if this elasticity didn’t exist, this particular transaction would not have taken place.

Cost

Cost is an important factor to consider when producing or offering a product or service. It involves multiple elements such as raw materials, utility bills, and services like marketing campaigns, salaries, rent, and much more…

There are two main types of costs:

Fixed costs are expenses that typically do not change over time and are usually independent of the quantity produced. These costs are often established by agreements and are independent of the quantity produced. Examples of fixed costs include insurance, salaries, loan repayments, and rent.

Variable costs, on the other hand, are costs that vary depending on the output of production or sales. As production increases, variable costs also increase, and if production decreases, variable costs decrease as well. Examples of variable costs include raw materials, commissions, and electricity.

Profits

Costs have a direct impact on profit. A company must take into account both fixed and variable costs when determining the price of its product or service, as well as supply and demand laws.

Profits = Sales – Total Costs (Fix cost + Variable Cost)

Companies that have propositional more variable costs compared to fixed costs are considered less volatile as their profit is more dependent on sales.

Keep in mind that all costs are elastic, meaning that they can change based on factors such as production output. For instance, let’s say a company is currently producing 10,000 pens and has a monthly factory rent of $1,000. However, if they expect to produce 50,000 pens the following year, they might need to move to a more expensive factory with more capacity and a monthly rent of $3,000.

Here’s how the costs would look like for different production outputs:

As you can see, the cost per unit can be greatly affected by production output. If the company moves to the new factory and produces at maximum capacity, the cost per pen drops from $0.10 to $0.06. However, if the company only produces 11,000 pens, the cost per pen increases significantly to $0.27.

In production or services, there are limitations, and sometimes it can be more profitable not to increase production, even if there is higher demand.

Conclusion

Price and cost are not interchangeable terms. Price refers to the amount that the customer is willing to pay to have a good or service provided, while cost represents the expenses incurred in producing or offering that same product or service. Understanding the difference between these two terms is crucial for businesses, as it helps them determine the optimal price for their products or services and make informed decisions about production and operations.