In a well-functioning market, the price should be driven by
  competition towards a level a bit above the production/R&D costs

The main issue is that R&D is largely a fixed cost. It takes the same amount of engineers to write the Bing engine or the Dropbox I/O layer, no matter how many users are using it.

How do you decide the strategy for recovering a fixed cost of millions of dollars from the price of the individual product? Price all DropBox accounts at $10 and you may not have enough margin dollars per account to cover your R&D. Price all DropBox accounts at $20 and you may not have enough volume to... cover your R&D.

Assuming the incremental storage for 50 GB costs $2, it's ok to recover $8 and $16 respectively for fixed costs. Just because they are fixed doesn't mean that the user shouldn't have to pay for them, or that it should pay in the same amount. You could argue even that the R&D should be paid in a 2:1 ratio as well by those benefiting from 100 GB versus those benefiting from 50 GB. It's the risk of the entrepreneur to decide where to set the bar so that, at the end of the day, the margin multiplied by the volume recovers the fixed costs.

Competition driving the price towards a level a bit above the R&D (fixed) costs doesn't work at all for products where the marginal cost is trivial but the R&D expenditures are huge. Why Ask, with 1-5% market share, cannot compete with Google Search, which has more than 60% in the US market? Crawling the web, building the index and removing spam costs more or less the same in terms of R&D if you aim for an approximative identical standard of search quality in the search engine. But having a market 10 times greater or 2 times greater (in Google versus Bing) means that one allows himself 10 times or 2 times the total fixed costs at equal levels on a per user basis. No wonder Bing losses millions while Google uses the ad revenue to subsidize its other operational branches.

The problem is that customers don't understand the possibilities well enough to pay on commission. Right now, software companies are forced to dump a ton of money into a product, and then use the finished product itself to educate users of the benefit of the product, at which point they can begin selling it.

In a "well functioning market" buyers would be aware of what sort of product could be built with what sort of development time, and would pay for the work. (I think this is what's happening with Minecraft - the people who bought the Alpha see themselves as funding its development).

My take on it, anyways.

While I bought Minecraft with the understanding that it wasn't done and I was helping support Notch as he continued to develop it, it's not a practice I'd do for a non-game product. I've spent well over $13 on games and had them turn out to not be fun, or only amuse me for a few days. If Minecraft didn't pan out, I've barely lost anything. If it turns out well, it will be more than worth the money.

Were it something important that I needed for my job, or were the cost less negligible, there's no way I'd throw a bunch of money at something and hope the inventor/developer/designer finished it adequately. If someone walked up to you and said "I'm going to build an electric car to compete with Tesla Motors, give me $80,000 and you can have the first one" what would you tell them?

EDIT: Kickstarter too. I've invested small amounts of money in things that I think are worth supporting, with the hope that they get finished well. But I'm not counting on it. It's a risk vs reward analysis that I'm willing to try, but only on small scales.

There's clearly people willing to pay the full price for the 595. If there wasn't, they would have cut the price already since it takes almost no effort to do so. People pay for the perceived value of the product, not the value of the underlying costs plus some margin.

Pricing based on cost is irrelevant because that has nothing to do with the value created or what people are willing to pay. E.g., why did Sony and MS sell the PS3 and 360 below cost for so long? Well, no one would have paid the $1000 plus margin that Sony would have needed.

On the other end, do you really think that bottle of Coke you buy is priced anywhere based on the cost of manufacturing? The ingredients in that cost about $0.02, but they charge $1 at the store. The 20oz bottle has maybe an extra couple cents of cost, but they charge twice as much.

To your point, Ask could have 5% share of volume, but if their ad platform was better to the point that they could charge 10x what Google could, they would be doing pretty well.

Re: Coke... They dong come anywhere near charging 2x as much for a 2x larger size.

I remember one day going into the convienience store near my office and finding that all the coke prices were identical, 1.69 iirc. The small bottle, the widemouth litreish one, the two litre, all the same price.

1) they do at movie theaters, restaurants, a lot of places. a 12 pack costs more than a 6 pack. etc, etc.

2) you still get the point. it's then even more clear that it has nothing to do with the underlying cost.

-sigh- ipad 'autocorrect'

s/dong/don't/

For commodity products, yes.

Luxury goods have never been "well-functioning" markets by the definition you appear to be using.

Hence the surprise of many consumers, I believe. They're actually being sold a luxury product, whose price is based a lot on branding/status/etc., but they believe, or want to believe, that they're buying a product whose price is based on the quality/cost of its inputs (and/or design, or manufacturing). So, 2x as expensive headphone is expected to be made out of better components, or constructed with a more expensive method, or something, and people are dismayed when they find that that isn't the case.

It is somewhat unfortunate as a consumer that the market has turned out that way, rather than as a more competitive market. It makes shopping for audio equipment a lot more time consuming, because prices don't have much to do with either production cost or quality.

The problem is that the companies producing luxury goods benefit from providing as little information as possible to their customers. It would be better for society if the companies with the most knowledge of how to produce a particular type of good could be incentivised to educate consumers rather than to capture as much consumer surplus as possible with dubious market segmentation partly based on keeping people ignorant.

This seems to me why people complain about IP laws. They encourage one type of good behaviour - innovation - but also discourage another type of good behaviour - sharing.

I cannot think of any other market with that much voodoo and obscure "magic" as high end audio equipment or (especially) guitar tube amplifiers.

And they make sure to keep their selling arguments to "musicality", "passion" and "emotions" because that is something you can easily sell, it gives you a very unique selling position and is virtually impossible for the customer to measure and compare.