Cost

We all understand what price means — whatever we have to pay for it. We also know that the price has something to do with the cost and we often use the two words interchangeably. But it is not clear what precisely is the difference between them.

For example, when we buy a widget for $5 — the price — but it could very well be that its cost of production and distribution was above or below that price. But generally, on average the price of stuff closely tracks its cost. If the revenue obtained from sales is below cost, the product or the firm is forced out of the market.

Where does cost arise from? Here I argue that the cost of anything is ultimately the cost of the energy that went into its production and distribution. Therefore, prices fall when energy costs fall, and vice versa.

Historically, prices of nearly everything have been falling. That means energy costs must have been falling consistently. This is empirically verifiable. The explanation for the downward trend in the cost of energy is simple: technology. 

Advances in technology in the production and use of energy reduce the cost of everything. For most of human existence, the only source of energy was human labor. Then with the domestication of animals which began around 11,000 years ago — horses, oxen, donkeys, mules — humans were able to increase agricultural output. Later, energy was extracted from wind and water. Windmills, sails, water wheels, and other ingenious ways were invented to provide energy for transportation and other uses.

Fun fact: Even after the advent of mechanized power in the 1800s, animal power remained essential, accounting for a third of all power consumed in the United States as late as 1900, particularly in tasks where machines lacked flexibility or efficiency.

For heat energy two major sources were wood and coal. Heat energy is critical for refining ores into metals and of course for cooking. A real breakthrough was the realization that heat energy could be used to do mechanical work. The steam engine powered the industrial revolution. The next major source of energy was the discovery of petroleum. The technological breakthrough needed was that of petroleum refineries.

From a barrel of crude, we get all sorts of products. The top refined bits are gasoline (they call it gas in the US), diesel (named after the inventor of the diesel cycle, Rudolph Diesel), and jet fuel (which is kerosene.) Crude of course is used to produce plastics and at the bottom of the distillation column, you have tar, etc.

After petroleum, came nuclear fission as a major source of energy. Sadly, due to ignorance and prejudice, the widespread development and use of nuclear fission energy was blocked for several decades. But I am confident that that will soon be a thing of the past. Small modular reactors (SMR) are in development, and they’ll be deployed soon. 

With every advance in energy source and energy technology, energy costs have been declining all the time. Furthermore, we are constantly figuring out how to use energy more efficiently. Modern cars, trucks, locomotives, ships and planes are more energy efficient than before. Every manufacturing process has also become more energy efficient. The two factors — more efficient use of energy and the lower cost of energy — has led to the decrease in the cost of stuff we use.

The next great advance on energy technology would be nuclear fusion. My educated guess is that it will be a reality in the next ten years or so. When that happens, the cost of energy will fall again to levels we can’t imagine.

Experts believe that humanity is around 0.7 on the Kardashev scale of energy use.[See note 1] Nuclear fission could easily advance humanity to 0.9 on the scale in a few decades. I’m an optimist.

I have digressed a bit. I will get back to the main claim: that the cost of energy is the only factor that determines the price of stuff. Here’s how it goes. Start at the top of the production process, of say, steel. The steps are mining of ores, refining, forging or casting, stamping, and a whole lot of steps, all of which requires transportation in between. All of those various steps require energy. They also require machinery. Production of the machinery requires energy. Then they all require labor, who are paid wages that are used for buying food, clothing, shelter and whatnots. Those things require energy.

Therefore, I claim that if a widget costs $5 at the store, then the cost of the energy that went into its production was $5. If that exact same widget was bought for $10, then the total cost of the energy is $10. The argument for this is left as an exercise for the interested reader.

Here’s the bottom line. I suspect that energy will eventually become so cheap that pretty much everything will have a very low cost. That means everything will be cheap. That will be the end of material poverty worldwide. Humanity will have attained superabundance.

Today out of the approximate 8 billion people, I estimate about 80 million people — roughly 1% of the population — enjoy superabundance. They can afford whatever they wish (provided it is available for purchase, of course.) I estimate that in the past, say the year 1900, this was possibly true for about 1 million. The population was lower, people were poorer (about 90% of the people suffered what we term extreme poverty today) and anyway there wasn’t all sorts of fancy stuff we take for granted now.

Even billionaires of 1900 (there were a few) could not have been able to afford much of what the average citizen of a developed country can buy. Why? The price would have been too high for those billionaires. Such as, you may ask? Intercontinental flight. The price of intercontinental flights in 1900 was infinite$. 

Alright, I’ll end this bit here. The previous bits were Cheaper All the Time,  and Energy Matters.

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Let’s listen to some good stuff. 

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NOTES: 

1. For a quick refresher on the Kardashev scale, here’s a bit that I edited from what the AI wrote: 

The Kardashev scale is a hypothetical measure of a civilization’s level of technological advancement, proposed by Soviet astronomer Nikolai Kardashev in 1964, based on the total amount of energy a civilization can harness and use.

It categorizes civilizations into three primary types: Type I, which can utilize all the energy available on its home planet (approximately 10^16 watts); Type II, capable of harnessing the entire energy output of its star, potentially through a Dyson sphere (around 10^26 watts); and Type III, which can access the energy resources of its entire galaxy (estimated at 10^36 watts).

Carl Sagan later modified the scale by introducing decimal gradations for finer classification and proposed a version based on information mastery, estimating Earth as a Type 0.7 civilization in 1973, though more recent assessments place it around 0.7276 in 2023.

The scale has been extended by some to include Type IV and Type V civilizations, representing those capable of utilizing the energy of the entire universe or a multiverse, respectively.