Economics is a study of human behavior, specifically of how humans make decisions about using the scarce resources at their disposal so as to best meet their needs and wants. They inevitably make such decisions multiple times each day.
My students learn that one way to understand the scope of economics is to take some minor incident in daily life and try to tease out as many economics topics as possible.
Since I am on vacation and have sworn off following national economic issues for two weeks, today’s column is just such an exercise. How many economics topics can one tie to my being charged extra for the amount of pickles I wanted on a sub sandwich?
It happened in Mankato a few weeks ago on a trip to the farm. I pulled off the highway at the local franchisee of a national sandwich shop chain. I ordered my usual “spicy Italian” on wheat with lettuce, tomatoes, onions and “a lot of pickles.” The store employee put a scanty handful of the latter on my sandwich. When I asked for more, she told me that I would have to pay extra. When I responded that I bought such sandwiches frequently and never had to pay for extra pickles before, she said it was a store policy. I told her I wanted the pickles anyway. She dribbled on seven more thin slices and I paid an extra 60 cents, itemized as “extra cheese” on my receipt.
A banal incident, but it was full of economics. For example, my sharper students would chortle, “But Ed, isn’t that just marginal cost pricing? And doesn’t that lead to efficient allocation of resources?”
They would be right. Charging an additional amount for an additional unit of some product is marginal cost pricing. And if the price charged represents the extra cost to society of producing the extra unit of the good, it does promote efficiency. Indeed, the harm to society from problems like pollution results from consumers not having to pay the full cost to society of the last kilowatt of electricity or gallon of gas that they use. And I don’t think it actually cost the sub shop 60 cents to place seven dill chips on my sandwich.
If marginal cost pricing is most efficient for society, why don’t retailers practice it? One problem for them is transaction costs. The administrative hassle of tracking the exact quantities of each component of a sandwich would waste employee time and extend waiting lines.
I did experience true marginal cost pricing once in a hotel in Bulgaria, where I was consulting on a U.S. Agency for International Development contract in 1993. The hotel priced each item separately, down to 3 cents for a pat of butter and 2 cents for 3 cubic centimeters of catsup or mayonnaise. The menu was 10 pages long and the service bad in all respects.
There is another element of marginal cost calculations in this. My preferred sandwich is the “BMT,” which has three kinds of meat. But it is excluded from this chain’s ongoing “$5 foot-longs” special. The Spicy Italian, with only two meats, qualifies. So if I want a 12-inch sandwich, the marginal cost of having the third meat is more than $4.
That leads to another topic, that of rational decision making. The shop charged me for extra pickles, but if I had instead asked for spinach, green or banana peppers or cucumbers, it would have supplied them at no cost. Everyone I tell of this incident says “That makes no sense at all,” and it doesn’t.
Furthermore, the chain’s multimillion-dollar ad campaign for $5 sandwiches inherently involves average cost pricing. Any of the ingredient cost differences for the different sandwiches included in the promotion are lumped together into one flat price. Why would a company stake a marketing campaign on averaging costs and them impose a marginal cost on minor extra ingredients? It doesn’t make sense.
Free-market fundamentalists would tell me that rational, profit-maximizing managers are always right and that there must be a profit-maximizing reason for the pickle surcharge that I am too dumb to understand. Perhaps. But history and my observations of life convince me that managers are sometimes irrational and often incompetent. That seems the case here.
It may be, however, that through extensive market research, they had determined that demand for specific ingredients like pickles is very inelastic and that fanatics like me will gladly pay the extra cost. In that case, imposing a surcharge would increase profits as long as it does not anger people and drive them to competitors in the long run.
My demand for pickles certainly was inelastic. I was glad to pay 60 cents more to have the sandwich I wanted, by gum! My decision was, however, one made with imperfect information. I did not ask how much extra I would have to pay, nor did I know that it would be seven slices.
Perhaps I plunged ahead and paid the surcharge because I did not want the people behind me in line to think I was a tightwad. That would be an example of conspicuous consumption.
In the future, I could also avoid the Mankato location and go to more customer-friendly stores in the same chain along my route. This multiplicity of competitors causes extremely elastic demand at any specific store even if demand for the overall product is more inelastic.
Economics, it shows up even in pickles!
© 2009 Edward Lotterman
Chanarambie Consulting, Inc.