Last updated on September 5, 2016
From a story on NPR’s The Salt:
Here’s the concept behind the new chain: Customers walk in and grab a to-go container of pre-made, healthful meals prepared by chefs who’ve previously worked in some of the finest restaurants in LA and New York. [Consumers] can heat up the meals in microwaves at the restaurant, or take them home. And everything is priced affordably–though the price changes, depending on the neighborhood. The goal is to make nutritious food more available to everyone.
The first location opened this summer in South Los Angeles, a low-income area. The next one will soon open in a well-off neighborhood of downtown LA, and there are plans for outlets in other parts of the city. Each location will have the same exact menus and decor, but with different price plans.
This is a neat idea for a pricing scheme. In microeconomics, we call this price discrimination, i.e., the phenomenon wherein different prices are charged to different consumers. Specifically, this is an example of third-degree price discrimination,* wherein different prices are charged to different groups of consumers. (The other two types of price discrimination are first- and second-degree price discrimination. First-degree price discrimination takes place when you charge each consumer the maximum he or she is willing to pay, and it is largely a fiction used to teach students that a monopoly can be Pareto efficient. Second-degree price discrimination takes place when price varies depending on quantity demanded.)
I think this is a neat idea, but I wonder how much its profitability will rely on two things: (i) consumers at high-price locations knowing that they are cross-subsidizing consumers at lower-price locations and deriving a certain amount of welfare from doing so, and (ii) a Stackelberg-like first mover advantage.
On (i), what I mean is that a random consumer–someone who has no idea that the chain charges higher prices in certain locations so as to subsidize consumption in other locations–might not be willing to pay more, which can threaten profitability. That is, increased willingness to pay in certain places might entirely rely on the warm glow (some?) people experience when they are being generous. To that effect, I suspect the chain will make sure to advertise their cross-subsidization scheme pretty effectively, and articles like the one linked to help.
On (ii), it’s hard to imagine a situation where many restaurants decide to adopt that kind of third-degree price discrimination system and get away with it. In other words, there is definitely an advantage to be the first to do this, and I have a hard time imagining a world where, say, fast-food chains also decide to charge varying prices in various locations.This certainly happens at a more macroeconomic level, however, when different levels of cost of living reflect people’s different willingnesses to pay. For example, the price of the same (non-chain) restaurant meal tends to be much higher in San Francisco or New York City than in Normal, IL or Cortland, NY.
What is interesting here is how the pricing scheme tries to link consumers willingness to pay (WTP) with their ability to pay (ATP). The two are not the same, as someone’s WTP (or marginal utility) depends mostly on their preferences, the prices they face, and their income, whereas their ATP depends only on their relative income, i.e., their income in relation to the prices they face.
If this works, this will be an interesting example of “private policy,” i.e., of markets organizing themselves so as to resolve a perceived market failure–here, the failure of markets to provide adequate nutrition to low-income households.
ht: Janet.