The Economics of Driving Around

It's time for a new feature here on Utah Economist Blog: The Economics of Driving Around.

I like driving around, and one of the best things about it is the real-world economics you can see as you go from place to place. Even if you don't like driving around, you probably have to do it --- and it's a great opportunity to look for economics.

I had some errands last Tuesday, and managed to catch a few snapshots.  I was also messing around with Instagram (a billion?  with a b?), and uploaded shots there.  The Economics of Driving Around really benefits from the geo-tagging feature of your typical smartphone, and I've linked so as to show you both a photo and a map.

So, here's a picture of some Powerbars.  This was taken at the Common Cents convenience store at Bangerter and about 200W.   And here's some more Powerbars --- the same kind, in fact --- taken as the Fresh Market grocery store on 900 East and about 17th South.

What's the difference?  Well, same product.  Similar display.  Difference price.  At the C-store, the bars go for $1.69 while at the grocery they are $1.59.  So here's where you can put your brain to work as you're out running errands.  Same product, so why not the same price?

Typically, people jump to thinking about cost differences, and very often to differences in the fixed costs associated with running each business.  But fixed costs don't (directly) affect optimal pricing decisions.  As we learn in a basic managerial econ class, the profit-maximizing price depends on two things:  marginal cost and demand elasticity.

So one possibility is that the convenience store pays a higher wholesale price for Powerbars, and selects a retail price accordingly.

But another possibility is that demand is more elastic at the grocery store than at the c-store.  Demand elasticity is a measure of how sensitive quantities are to prices.  If demand is elastic then small price changes lead to big quantity changes, while if demand is inelastic small price changes lead to small quantity changes.

It works out that if your demand is elastic (rather than inelastic), then it makes sense to charge lower prices and accept lower margins?  Why?  Well, the benefit from reducing prices is that you're going to sell higher volumes.  And if your demand is elastic, then a price reduction gives you a big increase in volume, and this big increase in volume can make it worthwhile to accept lower margins.  If, on the other hand, your demand is inelastic, then a price reduction gives you a small increase in volume, in which case it probably isn't worth it to accept lower margins to sell more.

All this can be made horribly precise --- the inverse elasticity pricing rule is the governing equation --- but the key point is to think about potential differences in elasticity in addition to potential differences in cost when thinking about price variation.

So the question then becomes:  Is there any reason to think that Powerbar demand would be more elastic at a grocery store compared to a convenience store?  Is there any reason to think that a c-store price reduction would have a smaller impact on quantities sold than a grocery store price reduction?  And that's a good question to ponder, as you're thinking about the why behind the price variation we observe every day.

Here's some more food-for-driving-around thought:

• 3.59 for regular unleaded
• 3.64 for regular unleaded