Hollywood Economics

I'm a big fan of the television show The Wire, which aired on HBO between 2002 and 2008.  It's a gritty police drama, by which I mean that every fourth word is profane.  If you watch it, wait til after your kids are asleep.

Stringer Bell (played by Idris Elba) is a terrific character who's the #2 man in a big Baltimore drug gang.  He's unusual for a druglord in that he wants nothing more than to be a legit businessman, and he's hoping to use his drug profits to invest in legal businesses that he can run after he retires from selling dope.  There's a great scene in Season 1 where the cops are tailing Bell as he drives to the local community college.  He heads into class where the professor delivers a lecture on demand elasticity.   Later, Bell walks into a copy shop that's he's purchased as part of his plan to go legit, and notices that his employees --- who appear to have been hired from the neighborhood based on criteria other than experience or skill at managing a copy shop --- seem not to be pushing very hard in the direction of superior customer service.

Bell expresses his displeasure, as follows:

Yo, you know what we got here?  We got an elastic product.  You know what that means?  That means when people can go elsewhere to get their printing and copying done, they goin' do it.  You acting like we got an inelastic product and we don't.  Now, I want this to run like a true (gosh-darn) business.  Not no front.  Not no (other stuff).  

Gritty, as I indicated.

As with all Hollywood Economics, however, they don't get it quite exactly right.  (It's not nearly as bad as the economics disaster that is A Beautiful Mind....)  On the outside of the classroom door that Bell enters at the CC, a sign reads "Introduction to Macroeconomics."  Demand elasticity is a *micro* topic, but close enough I guess.

Delta: Computer Glitch or Price Discrimination?

A current Executive MBA student sends a link to this article:  Delta Says Frequent Fliers Saw Different Fares

Nice find!

So maybe this is an unfortunate computer glitch on Delta's part, and maybe it's true that Delta Frequent Fliers were sometimes offered higher prices and sometimes lower.  Maybe.

But this is also perfectly consistent with a third-degree price discrimination strategy.  The rationale would go like this:  Delta knows that anonymous searchers are probably searching lots of airlines and comparing prices.  These travelers respond to low prices, which means their demand is elastic.  And as I discussed earlier today, it pays to offer lower prices when demand is more elastic.  Frequent flier club members are probably less likely to search widely and compare prices, and this means their demand is less elastic.  So Delta can increase profits by charging higher prices to this segment.

This is called "price discrimination" because the firm is charging different prices to different customers for the same product.  It's entirely legal --- although you can tell from Delta's response that it's often not a popular thing with customers --- and firms do it all the time.

(I do fly Delta a lot, and I hope they won't put me in the middle seat because of this blog post.)

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