Merry Christmas!

Merry Christmas to the readers of my blog!

Warm holiday greetings from feartheeconomist.com for your families! Hope you have a joyful, safe and a lovely Christmas spent with your family!

I hope Santa Claus was very generous this year!

Stay tuned for new blog posts soon :)

 

 

Why do fast foods raise their prices?

Has it ever annoyed you, when you walked into your favorite (but seriously, cut down on it, it’s unhealthy) fast-food chain with the last of spare change you have in your pocket thinking: “I”ll get the burger for the last quarters i have in my pocket” but then you find out that, well, you are going to starve because the just took the prices up the other day?

I hate it (now that’s what we call a first world problem…), but by saying that “chain owners are being greedy” is a naive explanation. As a matter of fact, there are a few reasons for this.

One of the first things that may happen, if a chain store is relatively new in the market, It can try buying customers by offering low prices when it enters the market. For example, at one point in Poland a McDonald’s cheeseburger was only 2 zł. (which was a bout 50 cents at the time). But soon enough the price has raised suddenly to 3 zł. Of course, we can’t neglect the impact of inflation, but this is rather minor.

Inflation is the rise of the average price level in an economy.

Even if we assumed a rate of inflation of 3% (although, the National Bank of Poland inflation target is rather near 2%), and that te price was changed after 3 years ( which is i think slightly longer than it actually held that price) we would get the Price

P=2 * (1.03)^2 = 2,12 [ zł]. So due to inflation we have a total of 6% increase inc the price, but still not 50%( from 2 zł to 3 zł ).

So where did the rest  - 0.82 zł – go to?

As I’ve mentioned earlier, the low prices were heavily advertised, being a part of the advertising campaign for McDonalds in Poland. It is even possible (but it does not have to ve) that McDonadl’s has been making losses in the time period where it charged that low price of 2 zł. Since McDonald is a huge Transnational Corporation it could afford making losses on once of it’s product. It probably made profits in the time period anyway in such a scenario from sales of other products(BigMacs and fires were much more expensive).

I Don't care about them prices, just gimme mah burger!

But thanks to heavy breanding, McDonal has decreased it Price Ellasticity of Demand. This is a measure of change in quantity demanded relative to the percentage change in the price. What this means is basically this:

If McDonalds hasn’t branded then: (quantities used for examples)

At the price of 2 zł for example, they would sell 10mln cheeseburgers a year

If they raised the price to 3 zł, then they would sell 3 mln cheeseburgers a year.

 

But since they branded:

At the price of 2 zł for example, they would sell 10mln cheeseburgers a year

If they raised the price to 3 zł, then they would sell 8 mln cheeseburgers a year.

 

PED(Price elasticity from demand) goes from elastic (tleft) to inelastic(right)

The branding has brought an effect that even though the price is higher, you will “still want it”. Whether that comes from the fact that you were convinced to the quality, or since you subconsciously want the cheeseburger because the commercials, more people are still ready o pay the price for their “favorite hamburger”. This might be visible for let’s say Macs and PCs. Since Macs had heavy branding  even though many people say they are overpriced, they still have a powerful consumer base.

Now why would they raise the price, they get less profit now form each burger! Well, let’s add up the number of how much revenue in total they got. So let’s see.

In the first case with no branding:

2zl each hamburger x 10, 000 ,000  burgers sold = 20, 000 ,000 zł earned

3 zł each hamburger x 3, 000, 000 burgers sold =  9, 000, 000 zł earned.

So if McDonald’s hadn’t branded, they’d only loose on taking up the price!

But in the case of branding:

2zl each hamburger x 10, 000 ,000  burgers sold = 20, 000 ,000 zł earned

3 zł each hamburger x 8, 000, 000 burgers sold =  24, 000, 000 zł earned.

So in the case when McDonals branded, an increase in the prices allowed McDonalds to increase their revenues!

So as we can see, McDonalds would just loose if their Price Elasticity of Demand was lower when they took the prices up (loosing revenue) – even if they were, as some people say “greedy”. An increase in the pirces was enabled only after a long effort, allowing McDonalds to increase their revenues.

The revenues are not the only reason why McDonalds just “raises the prices as they wish” . Since McDonald’s is one of the largest fast food chains in Poland - having monopoly power - it can just change the price as much as they wish.

Although recently the market of fast-foods in Poland has become more oligopolistic, but more on that in the next post. I hope this sheds some light on how fast food chains work, and why they raise their prices! :)

 

Mathematics + Economics = ?

In the recent times, it has been a matter of dispute to what extent we can apply our mathematical thinking into economics.

During the past years, there have been numerous attempts to do so: some more successful some less. As a matter of fact, some basic economic theories, such as the theory of comparative advantage, have a very strong mathematical basis.

As time has went on , people have started putting more and more faith to conjoining both of these sciences, despite the fact, that Economics are a rather social science, whereas Mathematics is well… a strict science.

Don’t get me wrong. Mathematics has done a great deal of contribution to the field of economics. If it weren’t worth, branches of these sciences such as Econometrics or Mathematical Economics would have never been created.

So you might want to ask: so if mathematics had contributed so greatly, then why all the hate?

Well, as they say: “Too much pudding will choke the dog”.

In our faith that we were able to predict so much based on these models, we have gone perhaps a few steps too far, when inventing the Black-Scholes formula. This was a financial derivative created to “secure risk”.As much as it WAS successful for an amount of time, it all went to “hell”, the second it had a chance to make a mistake.

The model has been unfortunately followed to strictly, causing it to be misused. This faith in the model eventually caused a propelled crash in the stock market, which it wasn’t created to predict.

 

The fall of the Financial Model

This NOT what we were counting for…

So the question is maybe not, if we can predict, but rather how far can we go with our predictions and application of math?

The answer is unfortunately not so simple. You live and learn, but I’m sure we’re yet to hear of something like the recent crash in the future…

Bus Fares

Any one of you people reading this – if you lived in a city, you probably used the means of public transport at least once. It sometimes might not be the top notch quality we’d wish for, but it’s there. And it works. Well, if we don’t count all the times you really needed to be at work or school on time and your bus broke down.

But as everything in this world, public transport does not come free. You’d think that by buying the bus tickets for your everyday journey, the government covers the cost of transportation. But it turns out that this is quite rarely the situation. As an example in my home city, the revenue from ticket sales covers only about 30% of the total costs of running public transport. In Michigan, the bus fares only cover about 20%!

So we might ask, why does the government run such a “business” if it doesn’t make any money? And who pays for running it?

Well, the answer to who’s paying the government is always us – the taxpayers.

 

But the answer for the firs question is a bit more complex.From an economists point of view, the main reason why governments invest into public transport is because of the positive externalities it brings to the society. A positive externality that coomes from provision of public transports are basically the benefits that the community gains from public transport.

The following diagram shows this situation. The MPB(=Marginal Private Benefit , that the government earns is represented by the MPB curve on the diagram. Above it is the MSB = Marginal Social Benefit, that is the gains that the entire society has from the governments actions. As we can see, the MSB is above the MPB, which means that as much as the government does not earn revenues from providing communication, the society gains, which contributes to growth and development. The MPC represent the Marginal Private Cost – so how much costs the government takes to provide the service. It is the same as the Marginal Social Cost, as bus fares do not really harm the society in any way ( one would argue pollution, but that is a very minor contributor in this case). 

Sop despite the government making “losses” on the bus business, it actually proves beneficial to the society, as it improves the communication in a city which makes the economy more efficient. Governments realize the benefits of these kinds of actions, which is why in some cities bus fares are only history. It is said that removing bus fares could actually cause more profit that charging for tickets.

In my opinion – free transportation is the way to go. Not only because i don’t like paying for my duty to go to school, as I usually have my ticket paid in full. It’s just in some situations I usally just happen to be the unlucky one to have my subscription ticket just expired the day before…

 

The Cola Battles

I won’t Lie: I love Cola. But every time i go to the corner store to get myself a bottle (or can, whatever floats your boat), I always have a problem of choice. One would say: “Whatever cola you choose, it’s still the same!”. But whenever i stand in front of the soft drink fridge in my local store i always have the dilemma: Coca-Cola or Pepsi?

It is rarely any of the other brands in the store, that take up 90% of space on soda beverage shelves. Don’t forget that Coca-Cola also owns a variety of other beverages than only cola such as: Sprite, Fanta, Minute Maid [=or Cappy as known in Poland], Nestea or Powerade. But Pepsi also engaged in the “Cola War” follows the competitor step by step with beverages such as : 7up, Mirinda, Lipton Ice Tea, Mountain Dew or Gatorade. Of course, there are some other producers in the market, but generally speaking , almost the entire market belongs to these two companies.

This is a situation of Oligopoly- where only a few firms have msot of the market share. Some argue that in certain markets Coca-Cola and Pepsi are a duopoly, where only two firms control the market.

 

The firm in Oligopoly sets the Price ant P1 since any alteration of the price, proves to be destructive for the firm. If Coca-Cola and PepsiCo started a pricewar, they would undercut eachoter’s profits. If one of the companies raised it’s prices, It would lose markte share as they would switch to the other.

This is why companies such as Coca-Cola and PepsiCo, tend to gain customers by non-price competition. Remember the Pepsi Generation featuring Michael Jackson? The animated Coca-Cola commercail, which evolved into a short-movie? What is more, recently, Coca-Cola is recently reviving a masala (an Indian mixture of spices) flavoured cola “RimZim”.

But who is winning the war?

There is not one answer to the question. As of 2010 for example, in the United States – Coca-Cola had 42% of the carbonated beverages as opposed to PepsiCo’s 29.3%, but as a matter of fact, the winner in India is definately Pepsi. What is more, as much as the Hoover(brand name) is the word for a Vacuum Cleaner in the UK, the word “Pepsi” is the indian word for cola.

Despite the differnce in the taste of both beverages: I have no specific favorite in Soda drinks which is why i simply bought one of each to take home today.

 

Sources:

http://online.wsj.com/article/SB10001424052748703818204576206653259805970.html

http://www.dineshbakshi.com/ib-economics/microeconomics/161-revision-notes/1771-oligopoly

http://en.wikipedia.org/wiki/Cola_Wars

http://www.dineshbakshi.com/as-a-level-economics/price-system-theory-of-firm/119-revision-notes/1776-oligopoly

Bloomber Businessweek, Issue 38/12

 

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