After the financial crisis of 2008 and 2009, my friend and I decided to start a landscaping business. Neither of us had gone to landscaping school nor did we have a particular affinity for lawn-mowers. (At least, not yet.) But hey, we thought, we live in Florida, grass grows like crazy most of the year, and, like haircuts, lawn mowing is pretty recession-proof. More importantly, we would be “business owners” instead of restaurant waiters.
This, of course, was before my deep dive into economics. Upon reflection, however, the economics behind our decisions seem clear. Back then I didn’t care about the concept of a “market price” or “equilibrium” price. When we started this business, we had no idea what to charge people for our services. But, before long, we were charging the competitive, market price without consulting anyone.
For example, one of the first lawns we mowed was 3/4th of an acre and a bit overgrown. I thought $40 would be about right; the owners thought they were getting a steal. I was guessing with the quote. I browsed the yard without knowing what I was looking for, thought about how I’m not really “qualified” to mow lawns, and blurted $40 because gas was only like $2.80 per gallon. I figured it would take about 1 hour to do this lawn with my handy-dandy push-mower.
Boy, was I wrong! It took my partner and I close to 4 hours to mow this lawn. After replacing two mower blades, paying for gasoline, and buying enough beer to soften the blow of our underestimation, we ended up paying around $30 to mow that lawn.
There was a market price for cutting lawns and I clearly did not know it. However, the only way to find out what the market price would be was by engaging in the process. When we would quote some people too high of a price, they would quickly negotiate something lower or mention that there were better offers by other companies. If it was too low, they would light up and out of nowhere, whip out a pen while asking “Where do I sign?!” suspiciously eager.
After acquiring 5 or 6 lawns, we were offering competitive prices–meaning, about the same price as any other company would offer. We did this without consulting anyone else. Likewise, all these companies come to the same price without consulting one another. How in the world does that happen?
Nobel Prize winner Vernon Smith wondered the same thing. How do suppliers get to the point where they charge essentially the same price for the same type of service?
In 1956, Smith took this question to the lab. In his classroom, he designed an experiment that would simulate a market in real life. Students were designated either “buyers” and “sellers” and required to “trade” with each other in an effort to make the most in “earnings” or “profit”. He did not tell the students the market price. They found it on their own simply by negotiating and trading. No matter what values they had as buyers and sellers (ranging from $10 to $22) they ended up selling for the market price ($16 in this case). The description of this game can be found here, here, and here.
In a competitive industry, like the lawn business in Florida, there is no “undercutting” the market price. If you charge too low, you go out of business. Too high, you also go out of business. The price you are quoted is often the “right” price. It’s as low as lawn companies can go without losing money and as high as they can go without losing the customer. It’s the equilibrium and market clearing price.
As mentioned, this price is reached through many trades. In the case of lawn service in Florida, millions of trades have occurred. If the price is artificially high, it would signal to the world that there is a profit opportunity and more lawn companies would open up. Because mowing lawns is so competitive, we can now be pretty certain of the market price for lawn service. According to Lawn Starter, the average price to mow a lawn that is 7,741 square feet is around $36. My first lawn was around 30,000 square feet. Even with shiny and huge, professional Zero-turn lawn mower, I should have charged around $150 to manicure that lawn!
In retrospect, I should have done just a little more research prior to giving out quotes. But in the end, I didn’t need this website to get to the market price. We too were charging the average for the 50 to 60 lawns under contract. Still, a little research into going rates and economic theory might have saved me a few expensive mistakes. Any potential lawn-salon entrepreneurs out there can thank me – and Vernon Smith – for this advice!
Now to figure out the market price for free economic lessons…