Prices, Profits and Low Income Consumers

September 9, 2010

This Hub is in response to the request which asked that I write about: For profit raising funds to help lower income families use their services?

I presume this question refers to for profit businesses allocating funds to subsidize the price of their product for low income consumers.

In their recent television commercials, some pharmaceutical companies are giving a telephone number or other contact information for consumers who cannot afford the medication being advertised to contact the company for information on how they can obtain the needed medication.

While I haven't done extensive research on this, I assume that these programs are at least partially motivated by a desire to offset the effects of demagoguery on the part of many liberal politicians and their fellow travelers in the mainstream media.

This is also a nice charitable gesture which can help put these companies in a more positive light for the population as a whole.

You must remember that while corporations are considered to be the same as individual persons before the law, they do not have the same emotions and act from the same impulses as real people.

Corporations are owned directly (individuals who own stock) or indirectly (people whose investments in things like mutual funds, retirement accounts, etc.) by living people most of whom invest with the intent of making money (in the form of an income stream from dividends or capital gains from growth).

As such the managers who run the day to day operations of these businesses and who make the day to day decisions must keep the shareholders interest in making a profit as their main goal. To the extent that charitable acts lead to a more positive image for the company and expand market share such acts of apparent charity are good.

However in cases where low income people are charged a lower price rather than receiving the product for free the motivation may be price discrimination rather than charity.

Occasionally a market situation exists in an industry where it customers are segmented into two or more groups each with circumstances or buying habits such that companies can charge one group a lower price without worrying about the other group taking advantage of the lower price opportunity.

The airline industry is a classic example of this, due to the existence of two sets of customers each with a different demand for air travel.

Businesses are big users of air travel as airlines are about the only option for quickly moving their people on short notice from one place to another to conduct critical business or take advantage of opportunities. Since the financial gains to the business from being able to move people quickly on short notice are usually very large, the company is usually not too concerned about airline ticket prices in these cases.

Consumers, on the other hand, usually use airlines for leisure travel which is both discretionary in that they don't have to make the trip, and can be planned in advance. With the travel being discretionary rather than mandatory, consumers have a choice and can easily decide not to travel if the price is too high.

Because business travel tends to be spur of the moment while consumer travel can be planned in advance, airlines have an easy way to separate the two groups and charge two different prices. Travelers who book and pay well in advance get a low price while last minute travelers pay high prices. This allows the airlines to broaden their market by including price conscious consumers without fear of having to extend the same low prices to their business customers.

While there are instances where businesses appear to be charitable and help low income customers by either providing their product or service at a low price or for free, these are generally instances where the business stands to gain more from the positive public relations than they are loosing by cutting the price. To remain successful, the bottom line profit must be the main goal of all businesses.

Ironically, it is by focusing on profit, rather than charity, that business has made its greatest contribution to helping society as a whole and especially the poor.

In accounting the profit equation is simple: Profit = Total Revenue - Total Cost

Profit can be increased by selling more and/or charging more either of which can (but not always) increase total revenue. If the business is also able to keep total cost from increasing at the same time then the increased revenue from raising the price or increasing sales will result in a higher profit.

Profit can also be increased by keeping revenue constant while reducing cost (and, in order to maintain the same level of sales needed to keep revenue constant, they have to reduce costs WITHOUT reducing quality at the same time.

In a free market economy, competition puts intense pressure on businesses to drive down costs through more efficient use of resources.  This cost reduction resulting from more efficient use of resources allows businesses to still make a profit while remaining competitive by steadily reducing prices.

Food is a great example here.  Until the last couple of centuries food costs consumed 50% or more of most peoples’ annual incomes.  By mid-twentieth century in the United States average annual food expense was still about 25% of household income (less for the wealthy and more for poor but about 25% overall).  Today the average American household’s annual expenditure on food is about 15% of their income.

Famine, starvation and malnutrition have been a reality for humans since the beginning of time.  However, famine and starvation are becoming rarer and rarer the world over and have been practically non-existent in the United States for over a century.   

Even during the Great Depression in the United States when many families struggled financially to put food on the table, actual starvation was rare and deaths from starvation amounted to no more than a handful of people.  The economy was even able to absorb the reduction in food production due to the slaughter of six million pigs and forced plowing under of thousands of acres of crops by the government of Franklin Roosevelt without causing actual starvation.

Other examples of the drive for profits by companies resulting in lower priced goods for low income people abound.  Cars used to be a luxury for the rich.  However, from the mid-twentieth century onward cars not only became more affordable each year resulting in increasing numbers of households being able to afford one but today most households have more cars than adequate space to store them.

When the first IBM PCs came out in the late 1970s or early 1980s they not only cost between five and six thousand dollars each but had minuscule memory ad storage capacity was limited to two five and one quarter inch floppy disks each with kilobytes (not megabyte or gigabyte) worth of storage.  

Users had one floppy disk drive for programs and one for data.  The Blackberry cellphone in my pocket has far more computing power than the first PCs and has a removable disk, measured in centimeters rather than inches, that holds megabytes worth of photos.  Of course the camera and computer features are in addition to its main function as a telephone.  

In addition to fitting easily into my pocket, the Blackberry cost me $199 (actually half that because I got a second one free, which I gave to my son, with the purchase of the first).

The list goes on, but it is the continual drive for profit by businesses in a free market economy which has resulted in a stead increase in quantity and variety of goods available and the steady decline in the prices that people pay for these goods and services that has resulted in the rise in living standards for rich and poor alike.