Russ Roberts

McKenzie on Prices

EconTalk Episode with Richard McKenzie
Hosted by Russ Roberts
PRINT
Don Boudreaux on Energy Prices... Kling on Hospitals and Health ...

Richard McKenzie of the University California, Irvine and the author of Why Popcorn Costs So Much at the Movies and Other Pricing Puzzles, talks with EconTalk host Russ Roberts about a wide range of pricing puzzles. They discuss why Southern California experiences frequent water crises, why price falls after Christmas, why popcorn seems so expensive at the movies, and the economics of price discrimination.

Size: 34.8 MB
Right-click or Option-click, and select "Save Link/Target As MP3.

Readings and Links related to this podcast

Podcast Readings
HIDE READINGS
About this week's guest: About ideas and people mentioned in this podcast:

Highlights

Time
Podcast Highlights
HIDE HIGHLIGHTS
0:36Intro. Southern California is prone to periodic water crises, droughts. It doesn't rain much there. Isn't that the source of the problem? Only rains about 11 inches a year, desert climate. But it also doesn't rain Mercedes Benz or Snickers in CA. Maybe the price has something to do with it. Price changes with supply and demand for those products. If you have unusual droughts in southern CA, the price is not allowed to rise--it is government controlled, so likely to get these shortages. Public officials appeal to people to cut back on water. Cuts consumption maybe 3-5%. If you hear other people cutting back you might even increase your consumption because there is more available; or might take water now before they send out the water police. Georgia. In Irvine you got a ticket for leaving your garage door open too long. Association contract rules. Grass police. The way your yard looks can affect the surrounding neighborhood but not widely enforced. Irvine does prove that perfection is overrated. Company town, medium strips mowed and edged.
6:50Water problem: Last week talked about peak oil; a lot of people see it as an engineering problem but it's an economics problem. Everything is scarce. No incentive for people to conserve. Gasoline situation--with price controls in early 1970s we had long lines and shortages. Tankers even changed course and went to Europe because they found they could get a better deal there. Even fistfights at gas stations. A ten-year-old girl started selling $10 coupons in advance and then disappeared--might be apocryphal story. It doesn't matter whether we are running out of oil soon or in 50 years or a thousand years--there isn't enough oil to go around at a zero price. It is the role of price that makes it plentiful. If you control the price you will get less supply and more people standing in line. Wait time can even mean people are paying a higher price. Higher income earners in the 1970s paid teenagers to stand in line for them. Friedman: people haven't so much learned that price controls are bad so much as they just still remember the disruptions of the 1970s.
13:06Flooding. Recent Iowa floods. In the event of floods should we feel sorry for those who are flooded? those who are nearby but not flooded? If you expect floods in the flood plain, you expect the value of property to be suppressed. The price differential should approximate the difference in losses when floods come. If the differential is too low people will continue to buy the hillside houses. If you have a flood that is not as serious as expected, the people in the flood plain got a benefit and those on the hillside paid too much. So, who you feel sorry for depends on what was anticipated. Suppose we start taxing the people on the hillside and use it to relieve those in the flood plain. Depreciates value of hillside property, more people will want to live in flood plain and will build bigger houses there and stocking them with better furniture; likely to have more newsworthy floods. Often people know that a flood is coming; if they know their damages will be covered by those on the hillside they have less incentive to pack up their belongings. John Stossel report on buying a house on NJ coast and puzzled to be covered against hurricanes by Federal subsidy even though hurricanes are known to come around. Law of unintended consequences. Benefits of these programs get capitalized and end up helping nobody. Can end up with no gains to the property owners. Anticipated flow of benefits of $20,000 by government would get captured in the value of the properties.
22:29Taxicab market in Manhattan, have to have a medallion, license. Getting a medallion gives you the right to pick up people; increasing number of medallions penalizes those who previously saved. Gordon Tullock: transitionary gains trap. Farm subsidy: many farmers bought their land at prices inflated by anticipating the government subsidies lasting into the future. 9/11 issue: Terrorists have probably killed more Americans since 9/11. When they flew the planes into the towers people feared flying; wait times have gone up with inspections. So more people drive; and since highways are more deadly than flying you anticipate more deaths. Three Cornell economists found that highway travel went up and estimated that 1250 adults died in first 12 months after 9/11 who wouldn't have. High price of gasoline implies fewer accidents. Administration has to be careful about raising alert status because it lengthens lines and increases jitters, drives people to the highways, and cause more deaths. Alert is kept at orange all the time. Sign: Free beer tomorrow. Dwight Lee, U. of Georgia, Athens, GA, anecdote: Russ flew to Atlanta shortly after 9/11. Shuttle from airport was probably more dangerous than the flight. TSA is careful about how it allocates its resources: checking grandmothers and babies also lengthens lines. But its rules get well known, so people can take advantage of that, too. Judicious use, management problem to use rules without discretion. Not much incentive to reduce the length of the lines. You can't complain to them or they'll strip search you.
33:52Why are there so many sales after Christmas? Standard answer: trying to get rid of particular inventories, maybe for tax purposes. But we observe storewide sales. Buyers typically aren't wrong about everything a store stocks, much less year after year. Many of these sales are planned--buyers place their orders back in July. Two different markets: urgency before Christmas; less urgency after Christmas. Inelastic demand before Christmas, more responsive after Christmas. Good form of price discrimination. Russ and John Lott, cost differences. Price discrimination is not necessarily the monopoly bad it's seen as. Car dealership podcast. Sign in a dealership: "If you want to haggle we'll raise the price so you can bargain it down and get a bargain." What is price discrimination? Firm has to have some pricing power, monopoly power. Item can't easily be resold or price discrimination would break down. Christmas would require a time machine to resell. If you start lowering your price after Christmas, can move date forward into pre-Christmas sales. Gift cards let receivers get some of the benefit of the sale. Definition is charging two different people different prices for the same good. Retail business is extremely competitive, same with restaurants. If you suggested to them that they have market power they would respond that it's unlikely. Response: fixed on idea of price competition being the only meaningful source competition. Schumpeter point: because there are economic profits to be made you have all of these goods to be made and people willing to risk a sizeable investment. Variety of goods. What if all the economic profit would evaporate once somebody created a product? Incentive for innovation. Non-price competition is important. Availability. Important way that stores compete is by keeping their shelves stocked. We are accustomed to seeing stock on the shelves. Stores don't want to run out of key items before Christmas, so overstock intentionally in advance. Airline ticket prices that go up at the last minute give a service to some people rather than just reserve the tickets and lose the money if not enough people buy them.
47:22World of pricing is complicated. Even the players in the business don't understand it but are driven by competition to come up with a good strategy. Popcorn. Why is popcorn expensive? Standard answer is that movie theaters are monopolists and once you walk through the turnstile they can charge whatever they want. But then why not charge even more than they do? Movie industry is selling a bundled experience: movie and other things. Interplay between the take the studio gets, the movie price, and the popcorn price. This kind of pricing strategy is used at Starbucks, McDonalds, etc. A small bag of popcorn is about $1.37 an ounce for a small bag in southern CA, much more than filet mignon at Costco, about on a par with sirloin at Outback. As you go to the medium or the big tub, where you might even get less popcorn because the medium bag is flexible and can be stuffed. The medium is 50 cents more than the small bag and the tub is a dollar more but you get free refills. A lot of movie-goers don't seem to be aware of the refills. If you consume 3 tubs the cost of the popcorn goes way down. If they are making a good deal of profit from concessions they have an incentive to keep the price of tickets down so they can raise the price of popcorn. They bid for movies; typical contract gives about 70% of the gate receipts to the distributor. If they have a movie they think will be a blockbuster they'll bid more, even though the ticket price might remain the same. The reason they are willing to bid so much is their high margins from concessions once people are inside.
56:10You don't have to go back to a theater that charges an unreasonable price. Theaters compete. Part of high margin may be that they are competing on getting access to the best movies. Part may be that the costs are not obvious. Labor cost, opportunity cost of space, people do bring in their own items in their pockets or eat before they come. Complex issue that looks like exploitation but is more complicated. Cost of popping the popcorn at home is about 50 cents; labor cost of their time, clean up, smuggle it into the theater adds up. Would it be better if you had a lot of popcorn vendors lined up along the walls? Fewer theaters would result. Money to be had in theaters creates market for good movies. Financial health of theaters. Theaters compete with sporting events, DVDs, home theaters. Thrill of seeing a movie with a bunch of people, and the unique flavor of movie popcorn. Smellable, audible edible. Some theaters will pop a bunch of popcorn just to get that smell. Concession counter is idle in one-screen theaters, but with multiple screens it is always busy. Empirical evidence. Multiscreen theaters should drive down the cost to the consumer, expect to see the relative price of popcorn falling over time. Efficiency gains are revealed in the film budgets. Strange that the price of popcorn and tickets are bundled that way. Would expect that movies would get more expensive over time--as we get wealthier we demand better movies; are we paying for them through the higher price of popcorn?
1:06:42Supreme Court antitrust decisions have affected the distribution. Art de Vany, Hollywood Economics. 1948 decision, vertical integration and movies. Risky business, hard to predict what movies will succeed, extreme kurtosis. Hopeless ignorance of the future. Movies are inherently unique products. Depends on buzz and also what else comes out the same weekend. Prices don't vary for movies because theaters are concerned about jacking up the price and causing lower buzz and less attendance down the road. "Sex and the City" movie line three blocks long. If you have an actor who can guarantee success that actor is in a good position to charge a very high price. Women's dry cleaning costs more than men's--looks like price discrimination but there are lots of actual cost differences. These puzzles are very complicated. Economics gives you a thoughtful framework. Women are more likely to return their dry-cleaning for damages or re-cleaning than men. Keep drilling down. The arguments that people think are the right argument are not always right. Coupons, Procter and Gamble coupon cartel to suppress distribution of coupons, taken to court.

Comments and Sharing



TWITTER: Follow Russ Roberts @EconTalker

COMMENTS (18 to date)
Ted writes:

Russ and Richard McKenzie spoke in this podcast about the 9/11 terrorists 'causing' additional highway deaths. While the aftermath of 9/11 may have led to more people on the roads and thus to more deaths, I would be wary of actually attributing those deaths to the terrorists or to the policies implimented by the NTSA. This would shift responsibility away from individual drivers and justify nanny-type regulations similar to motorcycle-helmet laws. I could envision, for instance, regulations limiting the number of miles a person may drive per year, etc.

I understand that Russ and Richard were merely pointing out the unintended consequences of regulations designed to keep us safer, but it's a short step from shifting responsibility away from drivers to 'protecting drivers from themselves.'

Or maybe I'm just paranoid.

Scott Anderson writes:

It seems that theater seats are alot like airline seats. The right to use a seat in a theater at a particular time is a perishable commodity. Airlines use a technique called yield management where the price of a seat varies based on location, time bought and route demand. The costs to run a movie given these constraints would be the per seat cost, labor, marketing, management and the facility cost, all fixed in the near term. The pricing strategy must have something to do with getting as many people into the theater as possible over a given period of time traded off againts the cost of facilities that increase as the size of the facility increases. More movies, more customers but higher fixed facility costs. The average customer views six movies per year. Concessions I would guess are much like the convenience store of a gas statiion. The gasoline is a low profit item to get as many people as possible into the stores. The ticket prices are set to get as many people into the theater, keeping in mind that there is a fixed cost per ticket to overcome (70% of ticket price) and that some movies are more popular than others.

I don't know how sophisticated theaters have become with pricing but it would be a very interesting strategy project to develop. The topic reminds me of "Super Crunchers" and Harrah's casinos. There seems to be a lot of opportunity here for theaters to use more advanced marketing techniques like loyalty programs, movie cards, yield management and other techniques to boost profits and cusotmer satisfaction. Even scheduling can be more sophisticated. Think of the long lines for popcorn just before the start of a movie. Many ideas, I would bet, have been thought of but I am equally certain not implmented given the operations that I have experienced at most theaters.

What about a movie club. I don't know what the distribution of movie attendence is but frequent users might be given the opportunity to pay a flat fee that covers most of the fixed costs of a facility (much like a utility) and allowed to go to any movie whenever they like. The profit would come from he concessions and from the higher priced one-off tickets of non-memebers, thus encouraging more frequent and planned usage of the theater.

I would guess that there are a lot of other better ideas out there.

For what it's worth,
When I worked at a Chick-fil-a for a couple of years, I was asked by the operator to note which size drink people had when taking advantage of the "1 free refill" policy. After a very short amount of time, it became obvious that people who purchased large size drinks (32 oz.), were by far and away the people who did the most refills. I can't say that they thought the large size and refill provided the "most bang for the buck", but that was my observation at the time.

Phil writes:

Re the price of drinks at Chik-fil-a:

Wouldn't a smart shopper buy the small (least expensive) size drink and just get up for more refills? Or is the time it takes to stand in line for another drink not worth it? How about other fast food restaurants where customers fill their own cups?

Re: the price of popcorn, etc. How about a simple research method? Ask the business owner how he arrived at his pricing model? did he test other models? Would he be willing to experiment with other models that might be more profitable?

Sometimes the straight forward approach is more effective and informative than trying to develop theoretical models and then find ways of testing them. Not always, but sometimes.

Scott Anderson writes:

Phil,

I think your approach makes alot of sense. You would probably have to talk to several chains (the pricing methods may vary) and they may not provide the information. Some may be leaders in their market and some may be followers, so do not really know why their price is what it is.

There may also be various product managers like concessions, tickets etc. (I have no idea if this is the way it happens). In which case, the coordination among the pricing of various products may not be very good, so the answer becomes more difficult to come by.

What may be even more interesting is devising strategies of what may optimize their profits. I jumped out to a couple of theater chain sites after typing the uninformed blog above and found that some chains have some sophisticated programs targeted at developing loyalty and volume. Some of those "deals" even included discounted popcorn if the customer fills a seat often enough.

Ed writes:

Good podcast. So it would appear that the entire movie industry is geared towards selling popcorn. I wonder what impact the rising price of corn has had on the movie industry.

Ed

Unit writes:

First a conjecture (based on my experience in movie theaters abroad): Americans associate going to the movies with eating popcorn, so popcorn-and-a-movie is sold as a bundle and thus one would expect the price of the tickets and that of the popcorn to be roughly equal, no? After all, if, when the movie is over, fresh popcorn were to be offered to the exiting costumers (sort of like a Christmas sale) I suspect that a price of zero wouldn't be enough incentive.

Also about after-Christmas sales: Americans associate Christmas shopping with busy shops full of busy costumers and many busy salespersons, lots of lights, decorations, etc...The theatricality of it all is costly to organize (need to hire temporary people for instance, stay longer hours, etc...)

What I'm trying to say, maybe incorrectly, is that it's the nature of the demand that drives these phenomena and the supply just tries to meet it as best as it can.

Marc writes:

Just another thought on Christmas prices -- Retailers are offering an implied return service with every gift that they sell. How many gift returns will have to be serviced? How many of those returns will be a complete loss (opened? damaged?) for the retailer. How many will be gifts that were not even purchased at that particular retailer? Among the other reasons mentioned we are paying for the losses that the retailer will take on returns.

Unit writes:

I have a small comment regarding the link "Elasticity and Its Expansion", by Morgan Rose. On Econlib. To illustrate elasticity of demand the author considers a young boy that sells lemonade and the different profits that arise from different selling prices. I find this slightly confusing, especially if one keeps in mind the law of supply and demand: at equilibrium the profits fall not matter in which direction the price is changed.
Maybe it would be better to switch from the point of view of the seller to the point of view of the buyers of lemonade, because it really is a property of the demand.

Mark Selden writes:

My wife points out that the movie/popcorn margins story parallels retail. Retail stores accept very low margins on products that bring people into the store, and take their high margins on the more commodity-like products. For example, Staples takes a low margin on a high-end HP printer (the movie) and a very high margin on general office supplies (popcorn and drinks).

Schepp writes:

Russ, Thanks for the podcast. I think that I am concerned about 1 idea. It is paraphrased as follows: When we get low on oil there will be something there to replace it.

Prices don't prevent scarcity, they simply allocate the resource more effectively than complex formulas or government decisions. There will only be a replacement for oil when it becomes scarce because seemingly outlandish people are now working on the solution. The more the pain at the pump the more the signal will be to the the outlandish to work on the change.

Your disappointment that folks are not do things because they understand ecomonics is also somewhat confusing to me. History and economics do not show the conquest of knowledge but the greedy choice to gain from agreements that create more benefits for the decider. The knowledge is limited to the provider who is paid by those who gain from the knowledge workers accomplishments.

Brian writes:

A really interesting podcast. I hadn't realized how little money theaters make on the tickets, and how much they depend on the sales of concessions.

One small thing to point out. It's right that people wouldn't buy the popcorn if their expected benefits didn't exceed the costs, however this also happens in a inefficient monopoly situation as well. While the two of you are correct that competition between different theaters does limit how far the price can shift from a true market equilibrium, the fact that the number of alternatives is so small once inside the turnstile does work to limit the elasticity of demand for the popcorn.

This monopoly like situation does permit the theaters to charge more than they would otherwise be able to.

T L Holaday writes:

Consider augmenting your taxi-medallion examples with another limited-by-rule commodity: the New York Stock Exchange handles seat. There is a continuous two-way market in New York Stock Exchange seats, with the bid and ask prices available to anyone interested. When the NYSE decides to increase the number of seats, every seat holder is issued a fractional seat in proportion to the increase. For example, if the number of seats is to be increased by 2%, every seat holder receives one-fiftieth of a seat. That way, the economic loss due to the dilution is offset by the economic gain of selling the fractional seat. A similar mechanism would work with taxi medallions and perhaps with other capitalized benefits.

James writes:

Question: Why are there sales on certain things when you would expect them to be in higher demand? Example: I noticed literally almost every kind of beer at the grocery store was on sale prior to the 4th of july weekend, when I suspect relatively more beer is sold.

Brian writes:

James, it's just a thought, but perhaps beer is rather elastic in demand. This would mean that decreasing the price at a time when the demand curve has shifted to the left (the time surrounding the 4th) they can get far more customers coming into the store than they otherwise would. Perhaps the store also hopes that these customers who are going in for beer will also buy other products which aren't marked down. They thus make up for their reduced profits in beer by getting higher sales in other regularly priced items.

Brian writes:

Oh sorry, I meant, "...when the demand curve has shifted to the right..." not, "...when the demand curve has shifted to the left..."

Amanda writes:

Just wanted to share an experience:
I was at an AMC theatre in Columbus,Ohio this past week and they let guests bring in their own food, just no alcohol. My jaw dropped. The ticket taker told us that it's because they know it makes it more affordable for people to goto movies.

Chris writes:

News story about the relation between gas price increase and traffic death decrease.
(http://www.physorg.com/news134913787.html)

Comments for this podcast episode have been closed
Return to top