The following is a guest post by Linda Jines — yarn merchant, book titler, and sister of Steve Levitt. Enjoy.
A Guest Post
By Linda Jines
The most recent episode of NBC’s hit comedy The Office offered viewers something extra along with its usual half hour of wry observations about life in Dilbertian corporate America. The episode, entitled “Broke,” included a lesson — an attempted one, at least — in microeconomics.
Some backstory: The Office, currently in its fifth season, is a “mockumentary” about life in a small, stagnant, Scranton, Pa., outpost of fictional paper company Dunder Mifflin. Office star Steve Carell plays Michael Scott, who until this season was the regional manager of the titular office. In a fit of pique, he left to form his own paper company — the Michael Scott Paper Company — which is now foundering, due to his marketing strategy of undercutting competitors’ prices.
In the Thursday, April 23, episode, Michael Scott consults with an accountant to determine how much he might be able to pay someone to make his paper deliveries. He’s told that he can afford to pay a delivery person nothing, as his prices are too low.
“Look, our pricing model is fine,” a Michael Scott employee tells the accountant. “I reviewed the numbers myself. Over time, with enough volume, we become profitable.”
This is where the economics lesson begins in earnest.
The accountant replies, “Yeah, with a fixed-cost pricing model, that’s correct. But you need to use a variable-cost pricing model.”
He goes on to explain, “As you sell more paper and your company grows, so will your costs. For example — deliveryman, healthcare, business expansion … At these prices, the more paper you sell, the less money you’ll make.”
So did the writers for The Office get it right? Is it truly and ineluctably the case that underpricing your product will put you out of business, no matter how many sales you drum up?
I decided to ask the resident expert on all things economic, my brother Steven Levitt.
I recited the accountant’s dialog to Steve (also a fan of The Office, as it turns out) and asked his opinion. He replied:
None of it makes that much sense, really — because usually there’s a fixed cost of setting up a business, and then there’s a variable cost every time you sell one more unit. But usually we think that the average cost per unit sold goes down the more you sell. It is completely possible that a company could go from unprofitable to profitable by charging the same price but selling more. On this one, I side with the Michael Scott Paper Company.
Uh-oh. Based on the accountant’s information, Carell’s character decides to close his paper company (in true Hollywood style, Dunder Mifflin rushes in at the 11th hour to buy him out and rehire him).
So was the Michael Scott Paper Company in the right with their ultra-low-price strategy? Steve replied:
No, I think they were probably charging too low a price, but not for the reason the accountant
My guess is they were charging too low a price because most companies that I’ve worked with closely — when you run the numbers — are charging too low a price. I’ve never seen an obvious example — again, with the companies I’ve worked with — of a company charging a price that is clearly too high.
This discussion of low prices was all well and good, but it was time to move it from the theoretical to the practical.
“What if HarperCollins decided to charge just $12.95 for the new Freakonomics book?” I asked.
“That’s a reasonable price,” Steve replied roguishly, “… for the first chapter. But what about the rest of the book?”