Archive for November 28, 2012

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…