Mind Your Decisions

Food Fridays: Buy Fresh—From Chinatown?

Several months ago, I discovered a great part of San Francisco’s Chinatown: extremely cheap produce. The food was dirt cheap and looked appetizing. But was it too good to be true?

I worried because I believe you get what you pay for. If a retailer sells a good for a lower price, there has to be a reason—lower quality, poor customer service, or shady business practices.

The price might be lower for reasons you might not understand, but economically, there ought to be a reason. Fifteen years ago while vacationing in India, I remember that clothes were cheap and of reasonable quality. I was happy to stop by small shops to pick up a few clothes, and it never crossed my mind to ask why the clothes were cheap.

On a more recent trip I was surprised at the changes. Small shops were replaced by bigger stores in brand new malls. Stores now had return policies, much larger selections, and some were even accepting credit cards—all things that I never saw in India before. But something else had changed: the price. Clothes were much more expensive, and approaching prices (after currency conversion) seen in American stores. After thinking for a while, it sort of made sense to me: there were added costs to the new retail practices, and those costs had to be reflected in the price. Things in India were still cheaper than America, but not that much. I imagined that with freer trade the prices would converge.

My guess is based on an economic principle—that a good should sell for roughly the same price everywhere—known as the “law of one price.” It’s an important principle, and it is used all the time on Wall Street to price complicated structured finance products.

Here is how my finance teacher intuitively justified the theory. Suppose pork bellies sell for considerably more in Chicago than Peoria. The price difference should instantly motivate Peoria sellers to ship pork bellies by trucks to Chicago. The movement of pork bellies will simultaneously raise the price in Peoria (because its supply decreases) and lower the price in Chicago (because its supply increases). Sellers will stop sending trucks only when the prices in the two cities have equalized, after accounting for transportation costs. This prevailing price is the one equilibrium price of the market. And the mechanism to equalize prices is called arbitrage.

And yes, there are notable instances when the “law of one price” does not hold. Trade barriers, information constraints, and physical constraints (you cannot transport haircuts) can prevent arbitrage from equalizing prices. But where arbitrage can take place, the “law of one price” should hold.

The law implies that you should be worried about deals that sound too good to be true. My friend once bought a new flat-panel monitor for half-price from an online seller. What explained the lower price? Well, it became obvious when my friend opened the box. The serial codes were suspiciously rubbed out, implying the monitor was most likely stolen. Clearly, the monitor’s warranty was voided, and the seller probably would not help if the monitor broke. Luckily my friend’s monitor worked, but if it was a scam, he had little recourse. He was too excited about the deal to question why the price was so low.

And that brings me back to my concern about the cheap produce in Chinatown. Why should Chinatown have such cheap produce? I worried a supplier might have been omitting things that might raise the cost, like inspecting for diseases. My paranoia and curiosity led me to conduct some online research.

Thankfully, someone else found the topic interesting enough to do a radio news story about New York’s Chinatown. The story indicates four explanations for the cheaper food:

1. Stalls are very small spaces so sellers face lower rent, lowering overhead costs.
2. Stalls are outdoors and fruit is not refrigerated, lowering operation cost.
3. A large customer base means high volume sales, which allow for profitable low margin selling.
4. Because big supermarkets demand long shelf lives for produce, wholesalers cannot sell ripe produce to them. Instead they sell the produce at a heavy discount to Chinatown shops, where buyers want food for immediate consumption.

The story relieved me. Yes, it defies common sense that you can get quality produce for cheap, but there are good reasons. I was happy to stop paying for “shelf life” of produce. And I could enjoy juicy Asian pears from Chinatown without worrying it was too good to be true.