HARDBOUND

Everyday Economics

How does Economics affect our lives? Journalist Tim Harford explains more in The Undercover Economist

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Published 3 years ago on Aug 13, 2017 Read

It’s time for a reality check. When we talk about big companies it is easy to get carried away with notions of how they are infinitely powerful and we are infinitely gullible. Not true.

Remember that no company has power unless it has scarcity, and often that scarcity is something we give them through our own laziness. Nothing is stopping us from walking down the street or driving from one store to another; certainly nothing is stopping us from a bit of mental arithmetic when buying chilies, or from glancing around for two seconds when buying potato chips.

Every store has a tiny amount of scarcity power, if only because it’s an effort to walk out and go next door. But some have more scarcity power than others, which is worth thinking about when estimating the risk of being waylaid by price-targeting strategies.

For instance, what is the answer to the question we posed in the previous chapter: why does popcorn cost so much at movie theaters? Is it for the same reason that wine is expensive in restaurants? We know that the first-glance answer in both cases is, “Because once they get you in the door they can charge whatever they want.” We also know that this first answer is probably not true. Customers may be dumb, but they’re not that dumb. People expect to be charged a lot for wine in restaurants and for popcorn and candy in movie theaters before they walk in the door.

Now we have a better answer: it’s likely to be a price-targeting strategy. Moviegoers who are sensitive to price will bring their own snacks from home, or go without. People who are not sensitive to price — perhaps because they’re on a date and don’t want to look stingy — will simply pay for the overpriced popcorn. Very clever.

This is a much better explanation, since in many towns there is only one movie theater, and even in towns with more than one, there is often only one showing the film you want to see. This gives a theater a lot of scarcity power, and if the manager is smart he’ll want to exploit that power to the full.

Yet the same story doesn’t ring true for pricey wine at restaurants. The typical restaurant has less scarcity power than a movie theater because in most towns there will be a variety of alternatives. Whenever there is little scarcity power, prices need to reflect costs. Yet even the most ordinary restaurants seem to charge a lot for wine. A better explanation is that one of the big costs in a restaurant business is table space. Restaurateurs would therefore like to charge customers for dawdling, but because they cannot do that, they charge higher prices for products that tend to be consumed in longer meals: not just wine but also appetizers and desserts.

We go to a movie theater to see a movie and to a restaurant to eat, so is the truth also that we always get gouged on “options”? Not at all. One option available in both movie theaters and in restaurants is the option to use the restrooms; this is always an option provided free of charge. Tap water is also free in restaurants. It is not the option that invites the gouging, it’s the lack of price sensitivity that allows a business with scarcity power to practice price-targeting.