Fairtrade?
Imagine for one second that you own a coffee shop (Not a Dutch coffee shop, just a shop selling cups of coffee). Assuming that after all costs have been tallied up it costs you exactly one pound to produce a cup of coffee, how much should you sell that cup for?
No matter what price you pick the result will always be suboptimal. Although a bleary eyed commuter may be willing to pay a high price, say three pounds a cup, for a morning caffeine fix on his daily stumble to work, you’ll miss out on the custom of the minimum wage employee, who may only be wiling to pay 1.10. Similarly if you price the coffee too cheaply, you’ll do a roaring trade, but all the people who would be willing to pay more end up keeping money in their pockets
In an ideal world you would find out how much an individual customer would be willing to pay and charge them exactly that much. This approach would maximise your profits, whilst keeping a maximal number of people happy. Unfortunately without a magical telepathic supercomputer at every checkout this will never happen. Coffee shops, therefore use a different way of allowing customers to self-select how much they pay, and the mechanism is choice. Take for example, Fairtrade coffee:
Cafedirect pay farmers an extra 40-55 pence per pound of coffee (enough to almost double their wages), however a typical cup requires only a quarter of an ounce of coffee beans, meaning that the additional cost to the coffee company is less than a penny per cup. For a time coffee houses were selling Fairtrade coffee at a premium of ten pence, and using the fairtrade label as a way of allowing customers who are willing to pay a bit more for a cup of coffee to do so.
Indeed none of the choices on the menu at a coffee shop have production costs that differ by more than a few pence (indeed, the actual raw ingredients are pretty cheap, it’s running a supply chain and nationwide stores that dominates the price), whereas the menu price will change by a factor of 2-3 between the cheapest and most expensive options. Choice provides a way for consumers to pay as much as they like. A spendthrift can get a black coffee for a pound or two, whereas a tourist looking to treat themselves can pay four pounds for a double mochalattechino. The cost to the actual coffee house isn’t too different.
This behaviour is pretty ubiquitous, for a time Amazon would track customer buying habits and alter book pricing accordingly (hey! he bought six harry potter books, lets stick a couple of quid on the price of the last one), but after customer complaints stopped this practice. Supermarkets sell about a billion different types of onions, from “cheep and cheerful value onions” to “deluxe, organic onions”, and on that note I have two last questions:
How much extra does it cost for a supermarket to sell organic food? How does this difference compare to the markup they charge?
Why do you never see ‘organic strawberries’ on display next to ‘normal strawberries’?
(This post inspired (i.e. stolen from) The Undercover Economist)

















