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.
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| 0:37 | Intro. [Recording date: un-noted. This transcript is being re-issued in November 2024.] Russ Roberts: My guest today is Richard McKenzie, the Walter P. Gerken Professor of Enterprise and Society at the Paul Mirage School of Business at the University of California Irvine. He's the author of Why Popcorn Costs So Much at the Movies and Other Pricing Puzzles. Richard, welcome to EconTalk. Richard McKenzie: Good to be with you, Russ. Russ Roberts: (00:58) Richard, you live in Southern California and as you point out early in the book, Southern California is prone to periodic water crises. Many people are aware of the fact that it doesn't rain much in southern California, but you suggest that strangely enough that isn't the source of the problem. Why not? Isn't it just a fact that it doesn't rain much in Southern California so they run out of water now and then? Richard McKenzie: (1:23) Well, the issue of water crisis in Southern California is one I love to bring up with my MBA students. At the start of the year, I ask 'em, why do we have these crises? And, immediately they'll raise their hands and interject that it just doesn't rain much and it only rains about 11 inches a year, which puts us in desert climate. And, I ask 'em, well, that's a very interesting answer and it would be a great answer in a class in atmospheric physics. But, this is a class in econ. And so, I asked them to press even harder and they looked sort of puzzled and I come back to 'em. I said, look, it doesn't rain much water in Southern California, but it also doesn't rain any Mercedes-Benz in Southern California or Snickers candy bars. Why do we have crises in water, but not in Snickers candy bars or Mercedes-Benz? (2:25) If we have a crisis in Mercedes-Benz, since I live near upscale Newport Beach, it's six or 10 'em crash at an intersection. And, that sort of brings them to the point that maybe the price has something to do with it. And, in the case of Mercedes-Benz, demand for Mercedes goes up, then the price goes up. If the supply of Mercedes is undercut, then the price goes up in Southern California where you have sometimes some unusual, the price is not allowed to rise. It's government controlled, and as a consequence, you're likely to get these shortages. And, when we do have these shortages and we've had one this year or last winter, we have the public officials coming out appealing for everybody to cut back on water. And, those appeals work to some extent, but they seem to affect only about, they seem to cut the consumption maybe 3%, 5%. (3:33) And, the logic of continued use is understandable. I mean, if you're a homeowner and you sprinkle your grass and you want your lawn to look good, then you know that you're not using much water and that if you continue to use at the same old rate, it's not going to affect the severity of the water crisis. So, you continue to use indeed, if you hear other people cutting back, you might increase your consumption because there's more available. Or if you hear these appeals for cutbacks, you might begin to think that, well, they're going to send out the water police next and you might as well get your water now before they take more serious actions of penalizing people for having their sprinkler systems on. And, we have had some of that. We have had water police going around, as has been the case in say North Carolina and Georgia over the past year or so where they've had serious droughts there. Russ Roberts: (4:36) Do you live in Irvine itself? Richard McKenzie: (4:38) I live in Irvine right next to the campus, the University of California, Irvine. Russ Roberts: (4:42) It used to be true that, I mentioned this I think a long time ago on a podcast. It used to be true that if you left your garage door open for too long in Irvine, you got a ticket. Is that still true or is that a myth? Richard McKenzie: (4:53) Well, these are association kind of rules that can be enforced by the association. If not, the city helps the association. Yes, in the association contract. You're not supposed to have your garage door open for more than 20 minutes at a time. Now, very few times do you have people actually enforcing it. Russ Roberts: (5:19) I was just thinking about the garage door police when you mentioned the water police, just Richard McKenzie: (5:25) Reminding we do have grass police. There was several years ago somebody convicted of allowing their grass to grow too long. And of course, the arguments for all of these restrictions is kind of the publicness of the way your yard looks and how it can affect the values of homes in the surrounding neighborhoods. So, I guess there's a logic, but you have to understand that these rules are on the books and I've only heard of one person actually being fined for allowing the grass to get above six inches or whatever it was. So, it's there, it's humorous. I mean in Irvine, I think Irvine does prove that perfection is overrated. Sometimes you long for messiness that comes with your typical urban center here. Irvine is a sort of company town. The Irvine company built it, and of course they wanted to maximize the value of the property, so they took special care to make the roads wide and the median strips green and let's see, the only town I've ever lived in where they not only mow the median strips on a regular basis, but they edge them and then they vacuum up the clipping. |
| 6:49 | Russ Roberts: (6:49) That's very nice. Well, let's go back to the rain and water problem. I like the example a lot. One of the reasons I like it is that in last week's podcast we talked about peak oil and a lot of people see the energy problem as an engineering problem, and I see it as an economics problem, and I think it's important to point out in this water example, I think brings it out beautifully that everything is scarce. It doesn't look scarce when it's priced properly. When we let prices adjust, when we artificially hold prices down, things suddenly get scarce and we say, gee, there isn't enough to go around. And, yet when we let prices move and adjust freely, there's always enough to go around, which I think gives us the illusion that those things are fine, but the other things, there's a crisis and it masks what reality is really about. You want to comment on that? Richard McKenzie: (7:45) Well, yeah, and I mean the reason again, we have water crises is that there's no incentive for people to conserve when in fact the rainfall is off for a year. And, right now the best thing that's happened in the current gasoline situation is that we've allowed prices to go up. Memories are sometimes short, but I remember the early nineties when we imposed price controls on gasoline and we had what you would expect long lines at gas stations. I mean sometimes the lines extended for a mile away from the pump and because of the controls on the price of gasoline, we actually during that period had old tankers changing course they were coming to the United States, but they found they could get a better deal in Europe. And, as I understand, the gasoline problems in Europe were far less severe than here. Russ Roberts: (8:51) You said the early nineties, I think you meant the early seventies. Richard McKenzie: (8:53) Yes, the early seventies, correct. Sure. There was a case in, I mean people forget that when we had these price controls on gasoline in the early seventies, there were literally fistfights at gas stations and gas stations would close down early because they'd run out of gas and they'd require buy additional services in addition to the gasoline. Then there was one enterprising little 10-year-old girl at least the story I remember is that there was this long line outside of a gas station, again, several blocks long, and she started selling coupons and telling the people in line that if you want to buy gas from my daddy who owns the gas station, you got to buy one of these $10 coupons that entitles you to X gallons of gasoline. And of course, she went down the line and kept on going. And, when they got to the gas pump, they were surprised that they bought worthless coupons. Sounds like I think that story is true. I Russ Roberts: (10:03) Doubt it, but it's a good story anyway, and I think there are a lot of historical examples of price controls where that kind of behavior was outlawed as part of the legislation. I think because even legislators are aware sometimes of how creative people can be, not the fake coupons but the real ones or requiring someone to buy can of oil for $20 with their cheap gas. The reason I mentioned the peak oil thing is that it doesn't matter whether we're running out of oil soon or in a thousand years or in 50 years. It doesn't matter whether we breach the peak of production or not. What is true always, regardless of where we are in the production path, is that there isn't enough oil to go around at a zero price and it's the adjustment of price which will occur whether we're on the downward slope of the peak or in the rising part of the peak. It is the role of price that makes it plentiful, which is why price is so important. Richard McKenzie: (11:09) And, I think people forget that if you control the price, you're going to get less supply. There'll be fewer gallons of gasoline in our economy if we keep the price at four 50 or whatever it is and not allow it to rise to $5 or $6 or wherever it's going. And, I suspect that few people in the world know where that price is going to settle, but you will have less gasoline. That means if in fact gasoline is critical to American production, you're going to get less American production and you're going to get more people standing in line. And, when you add the price, the fixed price of gasoline to the wait time of standing in line, you can actually, buyers can actually be paying a higher price because the supply is restricted because the price is controlled, Russ Roberts: (11:59) The full price, especially to people with a higher value of time than the average person or the marginal person is going to actually be quite a bit higher than it was when it was uncontrolled. Richard McKenzie: (12:09) And, one of the things that happened in the seventies when it was controlled is you had the higher income earners going out and paying teenagers to stand in line, Russ Roberts: (12:21) Which creates jobs, which is a bad way to create jobs. A really bad, inefficient and dumb economic policy. We've talked on here before, Milton Friedman suggested that the reason, I like to think that the reason we don't have price controls today despite the high prices, is because of the vast economic knowledge that has accrued to the American people since the seventies. But, Milton Friedman suggested it was really just that enough people are old enough to remember how badly they worked. So, I'm hoping there's some economic knowledge that'll protect us down the road when people do forget about the seventies, but it's definitely a factor. |
| 13:06 | Russ Roberts: Well, let's turn to a different issue. The other side of the rainfall issue. We talked about drought, let's talk about flooding. And, you have a lot of interesting observations in the book about flood insurance and federal programs to bail out people underwater, literally and financially. What are the impacts of good hearted even efforts to help people in times of flood? And, we're in the middle of a very tragic recent set of floods in Iowa. Richard McKenzie: (13:32) Well, this discussion comes out of another example I love to use in class because it startles students and that is in the event of floods, should we feel sorry for the people who are flooded out or should we feel sorry for the people who are not flooded? And, I use the example of a river going through a valley and you have houses down in the valley in the flood plain and you have houses up on the mountain side. Which one should we feel sorry for? And of course, the normal assumption of students is that you should feel sorry for the people in the floodplain because they've obviously had some losses. Well, I try to press 'em. Well, if you expect floods in the floodplain, what do you think is going to happen to the value of the property in the floodplain vis-a-vis the value of the property on the hillside and the students, they begin to realize that the price of the property and the floodplain is going to be suppressed, and then they can begin to think it through and say, well, if in fact the hillside lots and the floodplain lots are pretty much equal or comparable in all regards except for flood damage, the price differential between the two sets of lots should approximate. (15:00) The expected losses of when floods come, and so you have two, if both the lots in the floodplain and those on the hillside are valued at a hundred thousand and you expect damages of 20,000, then you should expect the price of the flood plain property to fall to 90,000. The price of the lots up on the hillside to go up to 110,000. If in fact the price of the lots on the hillside go to only 105,000, which means a $15,000 differential, you should expect people to continue to buy them because if you buy the $90,000 lot, you're going to incur $20,000 of flood costs. So, it's actually cheaper to buy on the hillside so you can get them to see that the price of the lots on the hillside go up and the differential will be about $20,000. Well, if you come to a flood and the flood is not as serious as expected but yet causes damage, say of $10,000, then you've got the people in the floodplain buying their house for 90,000, incurring $10,000 worth of flood costs, which is less than what the people on the hillside paid for their lot $110,000. (16:22) So, it comes back to the question, whom should you feel sorry for the people who paid the premium for their lot or the people who anticipated the flood and the flood wasn't as serious as they anticipated their overall calls from the lot, plus the flood damage is less. And, I think we've got to remember that before we just in a knee-jerk way, say, oh my God, these people have lost property. Some of it is anticipated. If in fact it's a flood of the century, then that's another matter. But, a lot of people buy in floodplains simply because it is cheaper and the flood losses are kind of cost of doing business or the cost of living Rus. What I go from there, I set them up and I say, well, let's suppose we start taxing the people on the hillside and using the taxes to relieve the damages of the people in the floodplain. What's going to happen? Well, if you tax the hillside, the property there is going to depreciate in value. If you start relieving people of their damages in the floodplain, then more people are going to want to live there and the price of the property can go up. And, not only that, since much of their damage is being covered by the people on the hillside, they're going to build bigger houses, they're going to stock them with more valuable furniture, and then Russ Roberts: (17:58) They're going to live there to start with, which in some places they would just choose not to live there because it'd be too risky. Richard McKenzie: (18:04) And, if you start doing that kind of thing, you're likely to have more notable newsworthy floods because again, people have an incentive to move into floodplains. And, as a result, if floods occur out in the wilderness, nobody cares. It's when they damage people's property so you can get a greater count of newsworthy flood that looks like everything's flooding. And then, when they hear that the flood is coming, and oftentimes people know that a flood is coming, if they know that their damages are going to be covered by the people on the hillside, they have less of incentive to pack up their houses and get out, so you're going to see more couches and lawnmowers and for that matter, cars floating down the river. So, it's a real bind, and I know John Stossel did a report one time I thought was extraordinarily good about how he bought out on the coast of New Jersey or some eastern part of the country and he was covered against hurricanes and he couldn't understand why he, a very high income earner would be covered in terms of damages when in fact everybody knows that hurricanes come along once in a while. Russ Roberts: (19:37) When you say covered, you're not talking about private insurance, I assume you're talking about federal. Richard McKenzie: (19:40) No, you're talking about federal subsidies in flood insurance or you have disaster relief and so forth. Russ Roberts: (19:50) Of course, part of the problem is that, as you say, every once in a while there's a flood of the century or a flood like we have now in Iowa that's dramatically worse than expected and the human heart rightfully goes out to those folks and wants to see them helped. And, of course, I'm all for voluntary efforts to help just as I suspect you're maybe not as enthusiastic about federal efforts or is that not true? What would you do in this case? Richard McKenzie: (20:22) I just think you've got to be extraordinarily cautious. It just means that the law of unintended consequences can kick in and bite you on the butt, and you just got to realize that there are some disasters maybe that we can help people out with through government, but it's got to be judicious, got to be very constrained. If it's not constrained, then the benefits of these programs get capitalized into the value of the property and you end up helping nobody. Now go back to my valley. If in fact we in a knee-jerk way just help all the people in the floodplain, then that means the price of the property is going to go up. The value of the anticipated damage release into the future is going to get capitalized into the value of the property. And so, you get people buying there into the future that they're paying a higher price, they're already paid out the cost of these damages and you can really get trapped and you can end up with no gains to the property owners. (21:35) Again, lemme give you an example. Property in the floodplain sells for $90,000 without future benefits coming from the government, there is an anticipated flow of benefits, say of $20,000 into the future. Well, those expected benefits can get captured or capitalized into the value of the property and the flood plain. So, somebody down the road, say next year, year after that buys a property for $110,000. Well, that person is no better off with the damage benefits than without them because again, the person's paying for the 20,000 upfront. Now you've got to understand all these figures are kind of rough, and I know you can get more precise in making these calculations, |
| 22:29 | Russ Roberts: (22:29) But, it's a really interesting example, and it's not only an example of floodplain or other types of government subsidies. The example that comes to mind is the taxi cab market in Manhattan where to operate a cab you have to have a medallion. The cost of medallion is very high and because they limit the number of cabs, so getting a medallion gives you the right to pick up people. And, if you think that's a bad system with so few cabs, which probably is probably a lot of people in New York, wish there were more, especially when it's raining, then if you start to increase either the number of cabs or medallions, you penalize the people who saved all the money anticipating the flow of benefits reasonably so because that was the law at the time legislation at the time, and it gives a certain inertia to government policy. Richard McKenzie: (23:31) It's what Gordon Tullock called the transitional gains trap that once you start providing benefits, so often these benefits get captured. I think he used the example of the farm subsidies. One of problems of getting out of the farm subsidies business when food prices are so high, is that many of these farmers bought their land at prices that were inflated by the anticipated subsidies well into the future. So, they might have a case that, look, you misled me. I was willing to pay these high prices because you more or less guaranteed the large S into the future. Russ Roberts: (24:17) Of course, some people are aware of the fact that government doesn't always keep its promises… Richard McKenzie: (24:22) So, it's an interesting, and in this case, it might be beneficial of course, to the extent that government has a reputation for not keeping its promises, the expected benefits into the future are tempered and that tempers the increase in the price of farmland. Russ Roberts: (24:41) Yeah. Richard McKenzie: (24:41) Let's go ahead move to another issue of the unintended consequence because I think it comes close, the 9/11 issue that I take up in the book. In the book I make this claim that the 9/11 terrorists have probably killed more Americans since 9/11, then they killed on 9/11 and the terrorists have been dead ever since 9/11. And, the question is, how could you possibly think that is the case? Well, when the terrorists flew those planes into the Twin Towers, they immediately increased the risk cost of flying. And, when the Transportation Security Administration started checking people more carefully, they lengthened the lines at airports, that increased the wait cost of flying. So, the overall cost of flying went up by the risk cost and by the wait cost. And, that means that you should have expected more Americans to drive rather than fly, and the nation's highways are more deadly than the airways. (25:48) And, as a consequence, you should anticipate more deaths on the nation's highways as a consequence of the growth of the increase in the full cost of flying after 9/11. And, sure enough, three economists at Cornell University have investigated the issue and they found that in the first 12 months after 9/11, flying went down by around five to 8% depending upon whether it's major or minor airport. Highway travel went up by billions of miles that are attributed to the 9/11 event. And, they estimated that in the first 12 months, something on the order of 1,250 Americans died on American highways that could not have been projected given all the models at the time, absent 9/11. So, you can imagine that in seven or eight years, we could very well have had a higher death rate on American highways than we had on 9/11. Russ Roberts: (26:56) It makes you feel better about the high price of gasoline, saving a few lives. Richard McKenzie: (27:01) Does have a silver lining. One of them is fewer accidents. But, what this also suggests, Russ, is that the Transportation Security Administration has to be very careful about raising the alert status at airports because if it hears of a rumor, just a rumor, they don't know whether it's right or wrong, but they think there's going to be a terrorist attack. And, as a result, they raised the alert status from what yellow to orange that can lengthen lines at airports. It can increase the jitters that people have. It can literally drive people to the highways. And, as a consequence, the transportation security administration can indeed cause the deaths of Americans on highways. And so, they have a real balancing act here about trying to save lives in the air versus the impact of their efforts on highway deaths. Russ Roberts: (27:59) Well, as far as I can tell, they do keep it at orange all the time. A strange phenomenon, I've made reference to the sign in the saloon that the permanent sign that says, “ Free beer tomorrow,” and orange alert is a very constantly strikes me as a real tragic example of bureaucratic ineffectiveness. But, I want to tell a quick story, Richard, about your co-author Dwight Lee. Yes. Right after 9/11, Dwight invited me to the University of Georgia where he teaches to give a talk on spontaneous order. I was a little nervous. It was only about a month or so after 9/11, but I told Dwight I was going to come anyway, and I flew. At the time I was in St. Louis, I flew out to Atlanta, and when I got there, I was immediately called my wife to reassure her that I was fine. The plane had landed safely. There was no problems. As you say, there were a lot of jitters. People were very nervous flying then, and it was a bit scary, but I got there fine. Then University of Georgia, as you know, is in Athens, which is, I don't know, maybe 40, 50 miles from Atlanta. Richard McKenzie: (29:21) I think it's more like a two hour drive from the airport. Russ Roberts: (29:24) Okay, so let's say a two hour drive. Let's say it's about a hundred miles. Well, it's on a two lane road, most of it as I remember it. So, I'm in a shuttle bouncing along a two lane road in the middle of the night. It wasn't raining, but that would have made it just even better, and that must have been many, many times more dangerous than my airplane flight. But, I didn't call my wife when I arrived safely in Athens. I called her when I arrived safely in Atlanta, which was a mistake. I should have told her I was fine after the Athens trip, the holiday ended at Athens, by the way, was very on top of the 9/11 precautions. And, I reassured them that I didn't think they were in the top 25 on lists for the next terrorist assault. But, in those days, again, people were so nervous they were very vigilant that that has changed I think wisely. Richard McKenzie: (30:17) And, what this suggests is that the TSA has got to to be very careful about how it allocates its resources. If it checks 95-year-old grandmothers gives 'em careful screening or five month old babies. They're diverting resources from checking other people. They can in fact be lengthening those lines and as a consequence, they can be driving Americans to the highways by failure to use common sense and recognize that lots of approach profiles just don't apply. Russ Roberts: (30:58) Yeah, the problem though, I think you're right. The problem though is that we live in an open society, which I treasure and cherish, and the rules that Homeland Security and the TSA uses are pretty well known. So, if it became known that they wisely skipped 95-year-old grandmothers, they would become an attractive way to do some damage. If you want to have safety, you got to give up some of that openness and transparency. It's a little bit, Richard McKenzie: (31:29) I understand that argument very well, and it's just a matter of using some judiciousness in some of these things. Of course, you can always plant a bomb on a grandmother, especially if they have a winter, if the grandmother has a winter coat on. But, if the grandmother has just a sleek dress, it's one of those things where they've got to be very, very careful. It's a real management problem and just I worry about rules that don't allow people to use any discretion at all. Russ Roberts: (32:07) No, I agree. Richard McKenzie: (32:08) By the same token, if the TSA can increase the efficiency of the checks, get those lines down, then they can actually save American lives. Russ Roberts: (32:21) Unfortunately, they don't have much of an incentive to do that. I was traveling on Mother's Day recently, went to see my mom, and I was struck by how badly it was being run that day. There was one screening station open, the line was backing up, and what's the customer? Well, if it gets really bad, I guess I could complain to Congress, maybe they'd listen. But, it's a very indirect form of feedback. And, more interesting thing to me was you can't complain to them because they'll strip search. You got to kind of smile when they drop your laptop or paws through your underwear. You got to just pretend that it's just the greatest thing in the world. Their authority is a little bit… Richard McKenzie: (33:10) Yes, and I take this issue up in the popcorn book mainly as a way of suggesting to Congress or whatever that the TSA needs to its mandate needs to be broadened a bit, that it don't ought be held responsible for highway deaths or at least be effects. And, the airways business should be balanced off against reports on highways. Russ Roberts: (33:44) Let, if they can get the lines moving more quickly, they can hire more staff that would be, or some other, other kind of, or maybe a higher salary. |
| 33:52 | Russ Roberts: Let's switch gears. Let's take an example that I found very interesting. I didn't completely agree with you. Why are there so many sales after Christmas? And, this is one of the examples again in the book that I really like because most people, especially people who haven't studied economics, have a very quick, easy answer. And, the economist has a little richer answer. So, why are there so many sales after Christmas? Richard McKenzie: (34:13) Well, the standard answer from my MBA, executive MBA students is that they're just trying to get rid of unwanted inventories. That is, they bought too many pink and green shirts, oddball kinds of things, and they're just trying to rid, get their inventories down maybe for tax purposes. And, I'd say, yeah, there are sales of that sort after Christmas, but what we observe in malls is storewide sales, 25% off of everything. And, what can we conclude about the buyer who buys too much of everything? Of course, buyers are going to make mistakes on some items, but everything, what should you do, especially if that buyer has excess inventories of everything year after year after year, and they generally come around to the fact that the buyer's either got to improve his or her performance or the person gets fired. Well, the point that I'm trying to get across with my students and in the book is that many of these after Christmas sales are planned, and they have to be planned because the buyers have to place their orders back in, well, as early as well, at least by July. (35:34) And, basically they're sort counting on after Christmas sales. And, it isn't so much that they're necessarily giving discounts after Christmas as they know that they've got two different markets, one market before Christmas where people have a certain urgency to get something to put underneath the Christmas tree, and then they have another market after Christmas where people have pretty much spent out, they've got their closets and cabinets full, and they just don't have the urgency to buy. And, we in economics say, well, the demand before Christmas is more inelastic than after Christmas. Or you have an inelastic demand before Christmas and an elastic demand after Christmas. And, when you have those differences, Russ Roberts: (36:51) By elastic you mean more responsive. Richard McKenzie: (36:34) You have different profit maximizing prices for firms. And so, there's, the point I'm pushing in the book there and other topics is that this is just a good form of price discrimination. I know you and John Lott have raised the issue of cost differences in such circumstances. I don't want to, I'd say, yeah, that's a good explanation, but Russ Roberts: (37:06) Well, not here, not in this case. I've got a different explanation, but go ahead, keep going. Richard McKenzie: (37:10) Well, anyway, what you do is if people have got to have it before Christmas, then you just elevate the price. And, if they don't have to have it after Christmas, if they have more time on their hands and so forth in that week of vacation, then you lower the price. And, again, I'll concede to cost differences, but the other point, as I explained to John, I don't see price discrimination as necessarily the monopoly bad that lots of people do. Go ahead, Russ, and give me Russ Roberts: (37:45) Your, well, first I want to mention a couple of weeks ago I did a podcast with a sales manager of a car dealership that I bought a car from. And, we talked about the strange world of new car prices and haggling and how some people are very uncomfortable in that situation, other people a little more comfortable. But, after that podcast, a friend of mine said to me he'd been shopping for some product, I don't remember what it was, and he said there was a sign on the wall. It said, if you want to haggle, we'll raise the price so you can bargain us down and get a bargain. So, it is an interesting world, the world of bargains and haggling. And, before we talk about this particular case of Christmas sales, I want you to talk a little bit more about the for price discrimination. I want to use some of those in trying to give you an alternative argument and it'll come up again. We talk about popcorn, which I want to turn to next. So, talk about what price discrimination, the idea behind price discrimination, what it is and why it's a profit maximizing strategy and what situations? Richard McKenzie: (38:54) Well, the basic situations, the classic explanation is that first off, the firm has to have some pricing power. Some people would call that monopoly power. And then, the other condition it can't be can't be easily resold. So, if you have two different markets, then if you sell at lower price and market A, if those people can resell it with ease and market B, which is being charged a higher price, then the price discrimination can break down a bit. Now it's a little bit hard at Christmas time. Russ Roberts: (39:36) Yeah, you need a time machine buy low. You need a time machine. Richard McKenzie: (39:39) Yeah. So, you need a time machine. You buy low after Christmas, but you can't sell it before Christmas. Russ Roberts: (39:45) You can hold it though until the next Christmas. But, they're carrying costs. I'm going to not going to use that argument, but you're basically right there. It's hard to resell. Richard McKenzie: (39:52) But, the after Christmas sales are beginning to break down a bit though, and they're breaking down because if you start lowering your price by say 40% after Christmas, then some store can get the bright idea, well, if on December 27th I have to sell it for 40% less, why not on December 24, I sell it for 15% less than the posted price. So, you get other people giving pre-Christmas sales, and some of that is emerging. Then stores have gotten into competition over the gift cards and people have realized that they can buy gift cards, give them on Christmas, and then the person gets the benefit of the gift, plus can buy more in the after Christmas sales. So, these sales are beginning to break down as oftentimes happens with good old fashioned competition. Russ Roberts: (40:52) Well, the definition of price discrimination is charging the same, excuse me, charging two different people different prices for the same good. And, in the paper you mentioned that John Lott and I wrote a while back, often we raised the point that a lot of times the cost of servicing a particular customer is not the same as the cost of another customer and that you'd want to take that into account in the case of Christmas. The thing that comes to my mind, and two things come to mind, give you a chance to respond to 'em. One is retail business is extremely competitive. I don't see a lot of pricing power there. So, that argument, which is often invoked by the way for restaurants as well to explain certain pricing puzzles, I find very strange because most restaurants and most retailers are in a desperate struggle to stay afloat. And, if you suggested to 'em that they have market power and the ability to raise price to some customers in hopes of making extra profit on 'em, it strikes me as a lot of times unlikely. That's my first challenge is that it seems to me to be a place where pricing is extremely competitive. My second example though would be the following… Richard McKenzie: (42:07) Can I respond to that? Russ Roberts: Sure, go ahead. Richard McKenzie: (42:01) Let me suggest that in economics, we are sort of fixed on this idea of price competition being the only source of meaningful competition. And, I would argue that the retail industry is in fact extremely competitive because of things like the ability to price discriminate. It's a kind of Joseph Schumpeter point because there are economic profits to be made as a result of price discrimination or pricing power. You have all of these goods coming out on the market and you have all these people willing to risk a sizable investment in order to get the economic profit. I, the economists hold up this sort of perfect competitive market as some sort of ideal and just think how competitive a market would be in terms of variety of goods and energy, if in fact all potential for economic profit. And, by that I mean profit above the absolute minimum if in fact all the economic profit would evaporate once somebody created a product. And so, I would say that some of this extreme competitiveness is consequence of the strong incentive people have to go after these unusually high profits. Many of them fail at it, I don't want you to know that, but they still go after it by willing to open stores by the dozens and so forth. Russ Roberts: (43:58) Well, I agree with you on the benefits from short run profit that Schumpeter was obviously talking about the opportunity to make money in the short run does create the incentive for innovation, and it's very important. I don't want to deny that, but to stick with the Christmas story, I want to agree with you a little bit that non-price competition is important. But, what I would think would be important here that you certainly, I know you're aware of, but you seem to, I dismiss it, is availability. So, when you suggest that the buyer is inept because year in and year out the buyer buys too much, I would suggest that one way, a very, very important way that stores compete is by keeping the shelf stocked. And, there's nothing more, I think, unpleasant to a customer and then find in America anyway that a store is out and the reason we are so accustomed to seeing stock on the shelves, because that's just what we expect. (45:03) And so, it becomes a form a place that firms compete on. And so, I would, in particular in the time before Christmas, running out of a key item, and I'm not talking about a fad item, but just general things like shirts and gifts that are standard gifts that people give each other scarves, etc., would be extremely costly to a department store. And so, I assume they overstock on purpose to minimize the chance, not minimize, but to reduce the chance of running out of anything that is going to be key. And, they can't predict what is going to be the most attractive gift in advance or what kind of trends they can guess. So, I assume, again, I certainly agree with you that you don't want to push the so-called perfect competition model, a model that I think is very powerful and useful, but easily leads to silly conclusions when taken too far. But, I think it's a really important part of the American economy and the fact that the shelves are stocked is a key form of competition. Richard McKenzie: (46:02) Well, I don't want to dismiss that argument at all. Sometimes you can only focus on one. And, I think in the book, I probably underplayed it, and I think you and John Lott again really did a great job in pointing out that one of the reasons for the last minute, the high price of airline tickets at the last minute is that the airlines are indeed trying to provide those last minute customers with the service. That is, they're reserving some seats for people who have to fly because of business or maybe deaths in the family. And, they know that if they reserve them to the last minute, there's a good chance that those seats are going to go unfilled. And, I think that's a very incisive point… Russ Roberts: (46:59) And, that cost will be lost then because you can't ever get that money back once the plane takes off. Richard McKenzie: (47:04) That's it, clearly is a part of the story. And, in fact, I think what we're saying here is that there are combo explanations for many of the pricing systems that we have out there. |
| 47:20 | Russ Roberts: (47:20) I've come to a slightly more, I don't know, I'm less dogmatic on this than I used to be, and my listeners will have heard this in other podcasts that we've talked. I thought that was an interesting argument we made. I don't know if it's right. I'm struck by the fact that Southwest doesn't have two week weekend booking in advance discounts. They have some discounts and they do have some last minute higher fares. But, the world of pricing, one lesson I've learned, and let's turn to the popcorn example. I think it's a great example of it. It's so complicated. Those of us on the outside who think we understand why things happen often have such an imperfect institutional knowledge of what's really going on in the business. Even the players in the business don't understand it, but they're driven by competition to come up with what is often a good price or a good strategy, such as keeping the stocks shelved at a higher inventory cost. So, let's turn to the example of popcorn. Why is popcorn expensive? Give us the standard answer that you hear from the person in the street and what some of the things that person's missing. Richard McKenzie: (48:30) Well, when some people hear about my book title, Why Popcorn Costs So Much at the Movies and Other Pricing Puzzles, they oftentimes will mutter, well, it's obvious the movie theaters are just monopolists, and once they get you through the turnstile… Russ Roberts: (48:48) They can charge whatever they want; they can charge whatever they want. Richard McKenzie: (48:52) That's right, because there are no vendors, other vendors are allowed, and so it, it's whatever they want. And, I'd say, well, if they can charge whatever they want, why do they stop at $5 and 50 cents for the small bag of popcorn? Why not $10, $12, and so forth. And, I've just been amazed that how this issue has evolved in my own thinking, and even since I published the book, I think I've gotten a better understanding. And, it is far more complicated than most people think because they don't understand a very important part about the movie industry. And, that is the movie industry is selling a bundled experience that can be composed of a movie and popcorn and a soda, and there's an interplay necessary interplay between the price of popcorn and the price of theater tickets, and then the percentage take that the studios get for the movies out of the ticket prices. Well, I think there's a more sophisticated answer by recognizing that there's some price discrimination going on in the popcorn prices. And, this kind of pricing strategy is used at Starbucks. It's used at McDonald's and all over the place, and the argument basically can be seen in terms of the pricing structure here in Southern California, a small bag of popcorn costs $5 and 50 cents. You get about four ounces of popcorn there, and that means you're paying about a dollar and 37 and a half cents an ounce. And, that seems extraordinarily expensive. In fact, I checked the price of filet mignon at Costco and Popcorn on a per ounce basis. A theater is about two, two and a third times the price of filet mignon per ounce at Costco. Now the comparison's not completely fair, but anyway, we're talking… Russ Roberts: (50:58) One difference being that they don't cook the filet mignon for you at Costco. Richard McKenzie: (51:04) And, that's got to be kept in mind. But, the price of popcorn per ounce at a movie at a theater is about on par with the price of sirloin at Outback being served with a vegetable and so forth. So, there does seem to be an unreasonable expense there, and I'll get to whether or not it's reasonable in a minute. But, do notice that here in Southern California, you can go from the small bag to the medium bag and you're going to double your popcorn. You're going to get about eight ounces, four additional ounces. Those additional ounces are 12 and a half cents an ounce. You go to the big tub. Well, here in Southern California, you stand a good chance of getting more popcorn in the tub, but you also stand some chance of getting less of popcorn in that tub. If you're going to buy a tub, you've got to count on getting the refills in order to get a better deal than on the medium. And, by the way, the reason you can get more in the medium than in the tub is that the tubs' sides are inflexible. The medium bag is flexible, and as a result, the concession clerk can actually stuff it in calls, those signs to expand. And, I have a video where I actually emptied the popcorn out of the tub, pour the medium into the tub, and it overflows. Russ Roberts: (52:35) Well. So, how much is the eight ounce and how much is the medium and how much is the tub? Richard McKenzie: (52:39) Oh, the medium is $6 50 cents more, 12 and a half cents per additional ounce over the small bag. Then the tub is a dollar more, but you get free refills. And so, whether or not that tub is worth the extra buck depends upon your willingness to get refills. And, a lot of moviegoers don't seem to be aware of the free refills. Many of them do. It varies greatly as to whether they get the refills anyway. You can see that if get, I think if you get two refills on the tub, and some people do, in fact they get a refill during the movie, then they'll get a refill on their way out of the movie. If in fact you consume three tubs, the added cost of ounce of popcorn is something like 8 cents an ounce. So, there's a high price of popcorn in the small thing, but as you get way it on the margin, the price of popcorn goes way down, which suggests something about, in my view, their cost structure. (53:49) But, you've got to understand that if in fact they're making a good deal of profit on the popcorn, and many theaters do view themselves not in the movie business. But, in the concession business, then you've got to understand that they have a very strong incentive to get people up to the counter and they want to get them through the turnstile. So, the theaters have an incentive to keep the price of tickets down and they want to keep the tickets down so that they can raise the price of popcorn. Well, theaters have to bid for their movies and some of them can bid. I understand from Art Devaney, a retired economist from here at UCI, who is an entertainment economist that the typical movie contract gives about for major movies, about 70% of the gate receipts to the theaters. Well, if you're giving up 70 cents on the dollar at the gate, Russ Roberts: (54:52) You mean to the distributor, not to the theater, you said… Richard McKenzie: (54:56) To the studio or distributor or whatever. Russ Roberts: (54:59) Yeah, 30% of the gate goes to the theater. Richard McKenzie: (55:01) That's right. And then, you have this product called popcorn that has a hefty margin on it that is at the margin. Then you can imagine the theaters have an interest in trying to get the price of popcorn down. They lose a dollar sale on the ticket, but they can put that dollar on the popcorn and they lose 30 cents on the ticket gain, maybe 90 cents at the margin on the popcorn, and they can increase their overall take. And, as a consequence, if they have a movie that they think is going to be a blockbuster, then they'll bid more in terms of percentage gate. And so, the studios can actually get a higher price for their blockbusters even though the ticket price remains the same. I mean, I've heard that the take on the tickets can go up 90%, 95%. And, again, the reason they're willing to bid so much is they can get people through the turnstile and sell them the high margin item that is high margin on the margin. And, Russ, I think you did an excellent job in taking up this issue, and I wish I'd read your piece before I wrote the book. |
| 56:16 | Russ Roberts: (56:16) No problem. Here's the question I have about this. First I want to remind people, we started off with this story that said, once you come into the theater, you're stuck. And, of course, as you point out, that doesn't let the theater charge as much as they want because people can still decide not to eat the popcorn. The more important point is that if you know after the first time, maybe you'd be disappointed if the popcorn was $15, you might be desperately hungry or it's such an important part of the experience, you might pay it once, but you don't have to go back to the theater. And, the theater that charges a reasonable price for concessions is going to have an easier time attracting people. And, we'd expect competition across theaters to bid the price down to where the margin of profit was enough to keep them in business but not excessive. (57:07) And, again, I would argue it'd be hard to imagine they could price discriminate unless there were limitations on entry into the business. And, there may be, by the way, which I'm not an expert on the movie business, but I do think it's important to remind people that as you point out in the book, that let's forget this price discrimination issue. Let's just look at the, so-called High Margin on Popcorn. Part of it may be because they are competing on getting access to the best movies, lowering the tickets prices, making sure that they draw people into the theater. Part of it's just the fact that the costs are not obvious. There's the labor cost, which I referred to earlier. There's the opportunity cost of the space. Obviously the theater would be dramatically smaller and have lower rent or would have more seats and more theaters if you didn't have concessions. (57:57) And, of course, as you've mentioned and as obvious to anybody who is ever been to the movies, if concessions get expensive enough, people do bring in their own, even if it's against the rules of the theater, people will bring in items in their pockets or before they come to the theater in their bodies, they'll eat before they come. So, it is I think, a very complex issue that on the face of it appears obviously to be an example of being the exploitation of consumers. When you think about it a little bit more, it is more complicated. Richard McKenzie: (58:27) And, most people who go through the turnstile, they see the price of popcorn and they seem to have two views on it. One is they look to the cost of popping the popcorn at home in terms of the kernel cost and the oil cost. And, that's about 55, 75 cents. According to my calculations, they forget about the labor cost of their time. If somebody values his or her time at $20 an hour and takes about a half an hour to get out the popper, do the popping cleanup and put it into a bag and willing to smuggle it into a theater and it takes a half an hour, that means that tub of popcorn is going to cost 10 to $11, which is more expensive than the price of the theater popcorn. The other thing, I think people imagine that the world would be a better place if we just had a whole bunch of popcorn vendors lined up around the lobby walls. (59:30) And, they don't realize that if you did have such an environment, the price, the competitive price would descend toward the marginal cost, which is the cost of the popcorn and the oil. And, there'd be no margin enough to cover the cost of the overhead, the labor, well, maybe some of the labor, but certainly not the theater itself. So, if there weren't some significant economic profits in the movie business, you'd have a lot fewer theaters and you'd probably have a lot fewer movies made available. And, by the way, it could be that one of the reasons we're having an onslaught of new major motion pictures is because there is money to be had in popcorn, which enables theaters to bid high prices for the films, which enables the filmmakers to go through all these elaborate, spectacular special effects Russ Roberts: (1:00:39) And, creates comfortable movie theaters with drink holders and nice seats. Richard McKenzie: (1:00:04) And, by the way, there may be a good deal of profit on the popcorn, but you got to weigh that off against the cost of everything else. And, I haven't checked on the financial health of the theater industry here recently, but when I was writing the book, writing this chapter, one thing you didn't want to do is buy Edwards theaters because there was an over expansion of theaters at the time, and the financial health of Edwards was somewhat shaky, Regal actually bought them out. So, you got to realize, again, I think as you've pointed out, that we have an entertainment market that's fairly competitive. Theaters are competing with sporting events, and they're also now competing with themselves on DVDs Russ Roberts: (1:01:38) And, against all kinds of things that are pleasant to do. Richard McKenzie: (1:01:40) And, I have reservations about, I mean, I just find it difficult to understand how they're going to be able to offer something better than you can get in a home theater. The quality of plasma and LCDs is far higher, at least from my vantage point, than the quality than you can get in a movie theater. Of course, you get the huge screen, but now we can get screens that pretty sizable in our living rooms for fairly modest costs. Russ Roberts: (1:02:01) No, I think that the only two things that are going to keep the industry going are the thrill of seeing a movie with a bunch of people, which has negatives as positives. And, of course, that unique flavor of the movie Popcorn, which we have not talked about, it doesn't taste quite the same at home. They do stuff to it, I guess they sprinkle some stuff on it and they pop it a little bit differently than we do. Richard McKenzie: (1:02:34) Well, it's theater Popcorn is designed to sell, it's designed to create the sense of urgency. And, in the industry, they call it a smell audible edible. Some movie theaters will pop a bunch of popcorn day or so before the screenings, but they'll make sure to pop some popcorn at the time of the screenings just to get that smell throughout of the lobbies. And, by the way, one of the reasons and one of major reasons for your multi-screen theater complexes is to make a more efficient use of the concession counters. Again, that's a Russ Roberts: (1:03:18) Very important point. Richard McKenzie: (1:03:20) Made the point that when you have one theater and one concession counter, that concession counter is idle for an hour and a half out of every hour, out of every two hour movie. If you have 18 screens, then you can have a constant flow of people through the lobby and the costs are lower. Russ Roberts: (1:03:42) And, if I'm right, John and I were right about that. And, again, I want to emphasize we didn't prove anything in that paper. We just raised the possibility that some of these explanations that people offer maybe are not right. Again, I think these are very complicated issues. I'm a big fan of competition. I think it's very powerful. But, I think it's interesting how both sides of this debate have done a pretty bad job on the empirical side of things. And, when I say both sides of the debate, I don't mean the popcorn debate, I mean the issue of how competitive any particular market is. But, it's an interesting thing if it is true that competition is a powerful force in the concession business and in the popcorn business, and that it's hard to price discriminate as a result and say the sizing or just the price of a bag between high end, high intensity consumers, high inelastic consumers, and those whose demands are more responsive. If that's true, then you would think that the more efficient multi-screen theaters would drive down the price of popcorn to the consumer because those costs savings of having the concession stand open through the whole time without the downtime where you have employees doing nothing, maybe sweeping up a little bit, but basically doing nothing as opposed to the situation with the multi-screen, you'd expect to see the real price over time falling relative to other types of what popcorn had been in past. I don't know if that's true. Interesting. Empirical question. Richard McKenzie: (1:05:16) One of the issues, one of the reasons I don't think you were able to find lower price popcorns at the multi-screen complexes is that the efficiency gains in those multi-screen complexes can be revealed and an increase in the film budgets. That is because their efficiencies of popcorn, more profitable theaters can bid more for the movies. And, as a consequence of bidding more for the movies, you can have films come out like Indiana Jones that are just filled with special, very expensive special effects. So, there may be the improvements in efficiency of delivering popcorn can show up in higher quality films or more costly films. Russ Roberts: (1:06:07) I like that theory. It's very clever. It is strange though that the price of popcorn and the price of tickets are bundled that way. And, I think normally you would expect if that were true, you would normally expect then that movies would get more expensive over time, independently of their other costs. But, lemme say that more carefully. As we get wealthier and prosperous as a nation, we demand better and better movies. Those get provided by the theaters. We would pay for them normally through higher ticket prices. You're suggesting it's possible we're paying for them through higher margin popcorn, which I would find more plausible, which I would find implausible. |
| 1:06:42 | Russ Roberts: But, as you point out, there are various Supreme Court decisions that have artificially affected the mix of concession and ticket revenue and distribution and theater revenue than would otherwise exist. Isn't that right? Richard McKenzie: (1:07:08) Yes. And, really, I'm leaning on Art Devaney again. He's an entertainment economist, has a great book called Hollywood Economics if anybody wants to go into it. We had a Supreme Court decision in 1948, antitrust decision that forced studios to divest themselves of their theaters. And, the argument was that the old vertical integration led to a monopoly of pricing in the movie business that is, studios could give their films only to these theaters and those theaters could charge a more than the rate of return. Russ Roberts: (1:07:46) What a bizarre idea. Richard McKenzie: (1:07:49) If that theory were in fact the case, you should have expected the price of theater tickets and popcorn to fall in the decade or so after 1948. But, they did exactly the opposite. I don't recall how much they rose, but the price increase for tickets was something some multiple of the increase in the consumer price index. And, again, the price increase was attributed or can be attributed to that 1948 decision. That is what it did is introduced some inefficiencies into the movie industry. And, by the way, the movie industry is one of the riskiest business around. It's very hard for movie executives to predict what movies will succeed. There is what Art Devaney calls extreme kurtosis in this movie. That's a statistical concept, but it means that basically no one knows anything or can count on much of anything. Russ Roberts: (1:08:53) That's a slightly less technical term for it. Kurtosis is one way of describing it. The other is hopeless ignorance of the future. Richard McKenzie: (1:09:02) And, part of it stems from the fact that movies are themselves unique products. It's not like one Mercedes, two Mercedes, three Mercedes, it's Indiana Jones and Ms. Potter and whatever that have their own, they just become a product unto themselves. And so, you do all the work, you invest all the money beforehand. And so, much of how well a movie does depends upon the buzz on the opening. And, it also depends upon what other movies are opening on that weekend. And so, you can have a movie that just happens to come out with some other big movies and gets swamped and leaves the theater in a week or two. And, by the way, the runs on these movies is the average of something like seven weeks. And, some of 'em stay only four weeks. And so, one of the reasons prices don't vary for movies is studios and theaters are very concerned about jacking up the price and causing fewer people to go. (1:10:10) And, when you have fewer people to go, you can have less of a buzz and you can have less attendance down the road. So, there's a tendency to try to keep that price down, not buck the trend, and hopefully you'll get the buzz going. And, you do have films like In Sex in the City that here in Southern California, my wife told me that the line was about three blocks long for that, and they did get that buzz going. But, part of the problem with the movies too is that if you have an actor who can guarantee a successful opening and profit, that actor is in a position to charge a very high fee and as a consequence drain the profits from the movies. So, there was some logic to this arrangement that we had in the forties where the studios owned the theaters because it made sure that the studios had theaters where they could show their films. It made sure that they didn't have to negotiate with every theater on the films, and then they could sort of develop bundles of movies that can eliminate some of the risk that comes with having individual films going here, there and yonder. And then, with the integrated industry, they were better able to balance the price of the concessions and the price of the tickets. Russ Roberts: (1:11:41) Well, yeah, again, just to mention it one more time, the complexity is very difficult to cut through from the outside and even from the inside. I would suspect that in many industries, insiders have trouble understanding why prices are what they are. What they discover is if they charge the wrong price, they go out of business. That's right. So, they may not know why prices the way it is. And, just to close with a classic example, we're running short on time. We've talked here before about why women's dry cleaning is more expensive than men's dry cleaning to clean a shirt. It turns out when you look more closely at that, there's about a thousand reasons that have nothing to do with price discrimination, which is the standard answer. But, there are a thousand reasons why women's clothing might be more expensive to dry clean than men's for one, they're different fabrics. (1:12:34) The men's shirt actually isn't dry cleaned. It's laundered. The machines are different sizes. An argument I don't find compelling, but that's a standard thing you hear. But, the deepest thing I once heard, and again, I don't know if it's true, but it's an example of how complicated these kind of puzzles are if you really want to get to the answer as opposed to have a good time talking about it. And, we've had a very good time talking about it. And, I think that's a lot of what economics brings to bear in these discussions. It gives you a thoughtful framework for organizing your thinking. But, in the case of women's dry cleaning, someone told me, and again, I like to hear it from someone in the business, that women are more likely to return their shirts for reclaiming or for damages than men are, which means that a female customer or female clothing is more expensive to dry clean, and we'd expect competition to force women's prices higher than men's. If you'd naively just charge the same price because you thought it was the right thing to do, you'd find yourself going out of business. Richard McKenzie: (1:13:30) I agree. And, what was great about writing this book is I saw it came to see it as a discovery process. I'd start off with some question like, why does popcorn cost so much at movies and keep drilling down on it? And, it just got more and more interesting. And, many of the arguments that everybody knows is the right argument turned out to have flaws, or at least there were other arguments to compliment it. Why coupons? Every economist thought that one up to price discrimination, too. But, that sort of makes you wonder if in fact, coupons just enable firms to make economic profits, then why did Proctor and Gamble organize a cartel of coupon distributors to try to suppress the distribution of coupons? And, they were taken to court by the consumers on that. So, anyway, all these issues I found fascinating the more I got into them and I continued to learn as I talk to others and read and think about the issues. Russ Roberts: (1:14:52) Well, you raised a lot of interesting puzzles in the book and you gave a lot of, I thought, very interesting insights and answers. My guest today has been Richard McKenzie, the Walter b Kin Professor of Enterprise and Society at the University of California Irvine. He's the author of Why Popcorn Costs so much of the movies and other Pricing puzzles. Richard, thanks for being part of EconTalk. Richard McKenzie: (1:15:14) Good to be with you, Russ. |
READER COMMENTS
Ted
Jun 23 2008 at 10:45am
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
Jun 24 2008 at 9:50am
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.
Stephen Goldsworth
Jun 25 2008 at 1:21am
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
Jun 25 2008 at 2:56pm
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
Jun 25 2008 at 9:21pm
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
Jun 25 2008 at 9:44pm
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
Jun 25 2008 at 11:53pm
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
Jun 26 2008 at 5:15am
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
Jun 27 2008 at 5:47pm
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
Jun 28 2008 at 12:06am
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
Jun 28 2008 at 7:03pm
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
Jun 29 2008 at 9:25pm
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
Jun 30 2008 at 6:20pm
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
Jul 3 2008 at 4:31pm
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
Jul 3 2008 at 11:36pm
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
Jul 3 2008 at 11:38pm
Oh sorry, I meant, “…when the demand curve has shifted to the right…” not, “…when the demand curve has shifted to the left…”
Amanda
Jul 8 2008 at 11:30am
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
Jul 11 2008 at 12:30pm
News story about the relation between gas price increase and traffic death decrease.
(http://www.physorg.com/news134913787.html)
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