Rip offs

The image on the last post (coupled with my readings of Tim Harford's The Undercover Economist) have stimulated memories of V's most persistent moan about London life: if there is one aspect of it that she is more likely to describe as a "rip off" than any other it is the price of eating out.

Her instinct is that menu prices should somehow reflect the underlying costs of the ingredients and the wage-bill. But here in London restaurant bills instead tend to reflect two varieties of scarcity. Firstly the scarcity of location (i.e the underlying rent) and secondly the scarcity that the restauranteur himself wishes to enforce by setting prices that generate the extra value of exclusivity and deter the inherently less profitable budget-conscious class of diners.

This kind of exclusivity is likely to result in higher profits for the owner simply because the patrons that remain undeterred are likely to be the less price-sensitive sort. Once seated at their tables everyone pays the same price for their food...which is why the wine list is there, and why the wines on it are so expensive compared to their wholesale cost. It is the scaled price of alcoholic drinks that allows the even less price-sensitive of diners to self-select, thereby allowing restauranteurs to squeeze the maximum profit from their positions of scarcity by taking more money off people who are freer with their income.

V will tend to regard city life staples such as the Starbucks latte as a total rip-off because she assumes that she is being asked to pay for the coffee and that the high price of even a regular cup means that the chain must be making excessive profits. (Comparing London prices to those in Guatemala will often adds to her sense of outrage!) In fact the beans themselves are a tiny part of the cost that the customer pays for.

Starbucks also charges considerably more for products that involve very small incremental cost increases for exactly the same reason that restaurants offer a wine list with a scale of prices: to allow those people who can't help but throw their money around to step forward and do their thing.