Ananish Chaudhuri: Deciding whether the price is right

Opinion

There has been discussion about whether New Zealand goods and services are over-priced after comments by a British rugby columnist, later supported by former All Black Justin Marshall among others.

So is New Zealand a rip-off? There are two separate questions that need to be considered.

First, is New Zealand a rip-off in the sense that our prices for day-to-day goods and services are higher than other countries, even after making the necessary corrections for differences in exchange rates?

The second question, and probably the more important, are those prices high because of deliberate over-charging by producers?

The answer to the first question is most likely "yes" and the answer to the second is most likely "no".

It is important to remember that the extent to which producers have power over the price they charge depends on how competitive the market is.

If a particular producer is making large profits by charging high prices, then it's most likely another producer will undercut those prices and still make enough profit.

In short, producers can charge high prices only if there are no competitors available to undercut their price and lure customers away. Or if the producer can somehow collude with competitors to over-charge all customers.

This implies that in markets with vigorous competition and many small firms, it would be difficult to keep over-charging customers because there are enough other producers around who can, and will, undercut prices if doing so will make money.

And if there are a whole lot of competitors, colluding with them all is a difficult proposition.

As such, the chances are we are most likely not paying that much for our daily dose of flat whites and the price we're paying truly reflects the underlying costs with not too much of a profit margin. A similar argument is probably applicable to hotel prices in popular tourist resorts.

But what about fine dining? This market does not have vigorous competition and the issues here are somewhat different.

Is $28 for an entree at a restaurant at the Viaduct Harbour too much? There is no clear answer to this question.

For those who go there and enjoy the food, along with the ambience and the view, the price probably isn't too much. And someone who is not willing to pay that price is surely not going to eat there.

The point is that the restaurant is not primarily interested in the price it charges but rather in the profit it makes. It's most likely the restaurant has calculated that it can get away with charging $28 for an entree and still enough people will line up to make it worth its while.

Because, if profits go up by charging lower prices, they would surely charge less for a starter.

Given that restaurants at the Viaduct or near the top of the SkyTower clearly enjoy the advantages of being in a premier location - and pay a premium on rent - they are charging the prices that maximise their profit. It's difficult to see how one can increase competition, in this regard, in an attempt to lower those prices.

If the view and the setting are not worth that much to you then you probably won't frequent these establishments too often.

Now, are there any situations where producers are deliberately over-charging?

Yes. It's most likely we're paying too much for our meat and produce at our local supermarket.

It is one thing to have to pay through the nose for exotic foreign foods that are shipped from a long distance away.

But that doesn't explain why we're paying top prices for locally grown meat, fruit and vegetables.

In the absence of hard data, we can speculate as to why this might be the case.

Auckland supermarkets are owned by one of two companies, either Foodstuffs or Progressive Enterprises.

The lack of competition in this market pretty much guarantees the supermarkets can get away with charging high prices.

But before we condemn the supermarkets, there is an important issue that needs to be noted. It's possible our supermarkets experience higher costs than would be true of supermarkets in other countries.

We all know the price a producer charges is related to the underlying costs. Large supermarkets have large fixed or set-up costs - it costs money to build and operate one of these stores. The cost is fixed in the sense that if you build a large supermarket, you incur the associated costs, such as building maintenance and air-conditioning, which is independent of the amount of goods that you manage to sell.

The more you sell, the less your costs become, on average, because the fixed cost gets distributed over a larger volume of goods, making each item less expensive to produce and sell.

So the extent to which average costs decrease depends on the volume of your sales. Herein lies part of the problem.

Auckland - and New Zealand - is a very small market. It is possible sales volumes are just not large enough to give the producers adequate cost savings.

But are costs too high? Or are they deliberately over-charging, given the lack of competition? The answer is probably a bit of both.

What is the average consumer to do? It depends if the convenience of buying everything under the same roof in air-conditioned comfort is important.

If you can spare the time, then drive to the nearest Chinese supermarket or farmers' market. Keep in mind this might mean having to make multiple stops for all the things you need during the week.

And what about heading out for romantic dinners? Well summer is just around the corner - pack a chilly-bin, grab a beach mat and drive to a scenic spot. We are lucky to live in a country where there are plenty of these in close proximity - and they are all free.

Professor Ananish Chaudhuri and Dr Debashis Bandyopadhyay are with the Department of Economics, at the University of Auckland Business School.