woweconomicsisthebest

[woweconomicsisthebest]

AAAAAHHHH

Anyone that’s eaten at the Wendy’s on campus may have noticed something interesting about the pricing. The famous 4 for $4 deal (which treats customers to a 4 piece meal for the price of a mere 4 dollars) is one dollar extra here, making it a 4 for $5 deal. This decision to exclude UCI from the locations that offer the 4 for $4 seems to frustrate some students 

So what's the economic reasoning behind a move like this? 

To understand why the deal is more expensive in Irvine, we must first understand why the deal exists in the first place. Why would Wendy’s offer a meal that’s so cheap? 

What goes into deciding a price point for a good?

In a vacuum, the industry standard price of a product would be determined like this:

(image from Study.com)

The graph above shows what pricing would be like in a perfectly competitive market.  The point where supply and demand intersect is the point of economic equilibrium, it determines what quantity of a good will be produced, and the price that good will sell for on the market. A perfectly competitive market assumes all actors are perfectly rational and that factors like price controls don’t exist; this makes the model useful when trying to conceptualize economic principles, however, its overly simplistic nature means it sometimes has little one-to-one real-world applicability. 3 major requirements for perfectly competitive markets are as follows:

1. There are many sellers

2. The product being sold is identical

3. Anyone can enter the market

(chapter 16) *note that there are more requirements, but for simplicity's sake we’ll focus on these*

This may sound like it describes every industry in a capitalist society, but upon closer inspection you'll find that many of the industries and products we interact with in day to day life don’t follow this model exactly. Let’s take a look at the industry Wendy’s operates in.

The fast food industry has many sellers, fulfilling requirement 1

While there may be some initial out-of-pocket and opportunity costs**1 associated with creating a restaurant, food (in a rough sense), is not a limited resource. It can be said that anybody who wants to begin producing food has access to the resources required to do so. This means that requirement 3 “anyone can enter the market” is fulfilled. With enough commitment, the average person should be able to enter the restaurant business.

(image from the OC register of In-n-Out founders, the Snyders)

The place where Wendy’s (and other fast food companies) diverge from the model for perfectly competitive markets is in requirement 2 “The product being sold is identical.” At first glance it may seem that Wendy’s, McDonald's, In-n-Out, or any other Burger restaurant are offering an identical product, but because the taste, ingredients, menu items, sauces, etc. each company offers are different, they are not identical products.

(image from Timmy Timato on Youtube)

It can be said that each company has a monopoly**2 on their brand. Wendy’s has a monopoly on Wendy’s products, McDonald’s has a monopoly on McDonald’s products, and so on and so forth. This means that Wendy’s operates under the Monopolistic Competition model. This means that firms determine their costs not based off of the industry's equilibrium, but instead based off of what maximizes profit for their individual companies. This is determined by the quantity at which marginal revenue (MR) equals marginal cost (MC)

(image from Wikipedia) *note that this graph is a firm’s short term equilibrium*

Because monopolies and monopolistic competitors tend to mark up prices in order to maximize profit, there is a bit more leeway when it comes to pricing. A firm may still be able to make a profit at a number of different price points, but monopolies will almost always charge the price that maximizes profit. This leads to a certain amount of deadweight loss**3. But remember, there is still a competitive element to a monopolistically competitive market. While the goods that are being produced in this market may be differentiated, they are still in competition with other similar goods. In order to survive, a firm must convince consumers to buy from them instead of the other guy, and how do they do that?

Advertising.

Monopolistic competitors are incentivised to use advertising because of the nature of the market they operate in. Oftentimes this advertising relies on promoting the quality of their good, or getting a trustworthy person to endorse their brand. However, things begin to enter a weird territory when advertisers start using their prices as a selling point for their good.

Making price a selling point for your product means that:

A) The price has to seem tempting to consumers. It should be much lower than what they would value your good at. In other words, consumer surplus**4 must be maximized.

and

B) you are locked into the promise of a certain price. If your costs go up, you can’t bring up price to compensate without generating outrage and hurting your brand’s reputation.

This puts brands that offer this type of deal in a precarious situation. Normally monopolistic competitors would value maximizing profit at the expense of consumer surplus, but having an ad campaign that stipulates that your product MUST cost a certain price inhibits a firm's ability to act normally.

This brings us to:

Why 4 for $4 was always destined to die

Because revenue must outweigh total cost for a company to profit, when a brand rolls out an ad campaign that promises a certain price, the company is put into a difficult situation. They can’t raise prices to increase profitability, so their only option is to clamp down on costs. Sometimes this works out well enough; but in cases where they are unable to keep those costs down, the brand is forced to rescind or alter their offer, which usually comes with consumer backlash. That makes these deals very delicate to handle. A common tactic to circumvent these issues is by offering limited time promotions

But when a company locks themselves into a promise by making it a staple of their menu they set themselves up to inevitably betray that promise:

Subway fought valiantly to keep their $5 footlong deal alive for as long as they could. They transitioned from a year-round deal, to a February-only offer… but alas, even this was not enough to save them from the inevitable. RIP $5 footlong.

Mcdonald’s thought they were slick by turning the dollar menu into the $1 $2 $3 menu, but nah, this is a worse deal. Also think about the fact that the dollar menu had an advantage over other deals (like the $5 footlong) in that it was not specific. McDonald’s had the liberty to swap out or remove items from the menu as they pleased, but it still wasn’t enough.

This image speaks for itself

As you can see, it’s extremely common for these types of promotions to fall apart in the long run. Let’s look at the underlying reasons for this:

bringing down production costs**5 could be disastrous as it has potential to bring down quality and thus hurt a brand’s reputation

As demand increases so does output level and thus so do variable costs**6

Outside factors such as taxes on suppliers or legislation on wages means your costs might go up

But if 4 for $4 was doomed from the start…

Why do other Wendy’s still offer 4 for $4?

If you go to the Wendy’s website right now, you’ll find 4 for $4 still being advertised. 

If you google Wendy’s 4 for $5 you may even have difficulty finding an advertisement where Wendy’s owns up to the fact that it exists. So why is Wendy’s trying to cover up this injustice? 

Let’s pretend we are Wendy’s for a second

(this is you^)

You rolled out a 4 for $4 deal that was massively successful, but as costs and inflation rise you are finding the deal to be less and less profitable. So what’s a Wendy’s to do? Change the deal to 4 for $5. You try it, but get a lot of backlash, forcing you to announce that 4 for $4 will return. Everybody celebrates and all is good… except you still need to make 4 for $4 more profitable. This is where price discrimination comes in. Price discrimination means that you charge different prices for the same product to different groups. You know you can’t sell 4 for $4 to some people, but in places where food costs are generally higher (places like Irvine California), you find that customers are more willing to pay that extra dollar for a 4 piece meal, in the context of their local market, a 5 dollar meal is still very cheap. Additionally, places where the 4 for $5 is a reasonable offer tend to be places where operation costs are higher (places like Irvine California), so it makes even more sense to charge them extra.

This all becomes possible when you think of how franchises work. Wendy’s (which is a franchise) sells its logo, recipes, business model, and overall brand to franchisees who operate semi independently. They are still beholden to company policy and have to pay a large cut of their profits to the Wendy’s franchise, but they do have leeway on certain things. This model allows different locations to offer different prices, while the company as a whole still gets to claim that there policy is 4 for $4. Pretty clever. 

But despite this, it’s unlikely the 4 for $4 will be able to hold out forever. Inflation will continue to rise and cost will continue to mount. The fact that Wendy’s has introduced a 2 for $5 deal at all locations is a sign of their weakness. Some Wendy’s may be safe for now, but it's all a matter of time, the dawn of the 4 for $5 is upon us. 

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1- opportunity costs refers to the cost you incur from pursuing one path over another. If you quit your job to open a restaurant the money you would have made if you had chosen to keep your job is considered a loss. This loss is an opportunity cost

2- a monopoly is when only one firm controls all of a market

3- When there is a gap between the amount produced, and the quantity that is socially optimal

4- Consumer surplus refers to the difference between the maximum value a consumer would give your product, and the price they actually pay. 

5- cost incurred during the production of a good

6- cost that are affected by the level of output

Shannon Horan

ID:68512759

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