Readers Question: an orange juice sells at $3
when sugar price rise, orange juice sells at $3.2
but why when sugar price drop, orange juice still $3.20?
Why?
Sugar is an ingredient in the price of orange juice, therefore if the price rises, firms pass on the cost increases to consumers. Because all the firms pass on the cost increases, firms do not really lose any sales and market share should remain the same. Demand for orange juice is fairly inelastic, there are not many close alternatives. If the price of orange juice increased, would you stop buying it?
This is straight forward. However, if the price of sugar falls why does this not get passed on to consumers.
Well, a firm may think if I cut prices I will be more competitive and therefore, more people will buy it. However, if I cut prices then others will follow suit and we will all be worse off. Therefore, it is better to keep prices high and make more profits. Here, there is little incentive to cut prices, especially if you assume other firms will follow your example. Every firm wants to hope prices remain high so they don’t cut them.
Also, there is an inertia and menu cost in cutting prices. It is easier to leave them where they are.
However, this might not always occur, if the market for orange juice was perfectly competitive prices would fall.
Readers question
a house sells at $400k,
when steel price n cement rise,house sells at $450k
what will happen if steel n cement drop,
house price drop or remain the same at $450k?
how can this be explained in economics?
Do you mean new houses or old houses?
Most houses in the UK and US are much higher than the actual cost of building them. The price is inflated by a shortage of supply, therefore, the price of raw materials is only small % of the final price.
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