Easter surcharge confusion

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When I had breakfast in town over Easter I was charged a 20% surcharge on everything, allegedly because their labour costs are higher over Easter. Now it’s true that they are statutorily required to pay more over the Easter break, so their labour costs are higher; however, the marginal cost of providing a meal is not. The average cost might be, but that could be defrayed over the course of a year if the firm planned to open on Easter. If the marginal cost of the meal is no different then why would you price the meal differently?

A non-economist friend suggested that they ‘just want more money’, but that is always true of a business and should hold throughout the year. Next I considered that demand might be higher over Easter, but I can’t see why it would be different from any other weekend breakfast demand. Weekend demand might be higher, but then why not price all weekends higher than weekdays? One could point to reputation damage if they were seen to be ‘price gouging’, but it’s easy to phrase it as ‘discounts on weekdays before 6pm and look acceptable.

I really can’t think of any good reason why cafe prices are higher over Easter. Either they’re not pricing optimally the rest of the time, or they’re losing money over Easter by overpricing. Either way, they’re certainly not telling the whole story about why csutomers have to pay more!

  • http://www.tvhe.co.nz Matt Nolan

    I would say that the marginal cost of Easter is higher – as labour is a variable cost (since workers are paid per hour).

    Furthermore, given that supermarkets and the such are closed, and given that Easter involves a whole lot of families meeting up wanting to impress each other, I imagine that demand for cafe services would be more inelastic.

  • http://www.tvhe.co.nz Matt Nolan

    “Now it’s true that they are statutorily requried to pay more over the Easter break, so their labour costs are higher; however, the marginal cost of providing a meal is not”

    I see that you are saying that the marginal cost of an additional MEAL isn’t higher – so the cost of a MEAL shouldn’t be any different. The relevant unit is the meal, not the hours of work …

    I was wrong, I mis-specified my response, sorry.

    As a result, I would stick to the demand story.

  • http://www.tvhe.co.nz rauparaha

    Higher demand does seem to be the most obvious reason for it, I agree. I didn’t think about the fact that almost everything else is closed, so cafe demand is higher. That does seem to explain it.

    It still bothers me on an honesty level that restauranteurs point to labour costs and blame the government, though :P

  • http://www.tvhe.co.nz Matt Nolan

    Indeed – the higher labour costs determine their decision about whether to be open for an additional hour or not, not the price of individual meals persee.

    It must be dirty old demand – why can’t flippen supermarkets be open :)

  • http://bradtaylor.wordpress.com/ Brad Taylor

    @rauparaha

    “It still bothers me on an honesty level that restauranteurs point to labour costs and blame the government, though”

    It’s still the government’s fault, just through a different mechanism.

  • http://www.tvhe.co.nz rauparaha

    @Brad Taylor
    Haha, that’s true, we can still blame the government :)

    I don’t think that it’s any more honest just because the person you accuse happens to be respinsible in an entirely different way, but I guess we can still hold them responsible. Although now we have to weigh up the benefits of the public holidays against the cost of the surcharge.

  • http://www.tvhe.co.nz agnitio

    I don’t think the increment from a restaurant’s perspective is an individual meal so I think focusing on the MC of a single meal is the wrong approach.

    Haven’t thought it through much more than this, but I think saying that wage costs are fixed and therefore should be ignored in meal prices might be overly simplistic.

  • http://www.tvhe.co.nz Matt Nolan

    @agnitio

    That was my very first impression – but then I realised quite quickly that I was full of poos. The unit of production is the right measure for marginal cost, and staffing levels only provide capacity in this setting, they don’t determine output.

  • http://www.tvhe.co.nz rauparaha

    @agnitio
    I agree with Matt. Actually that’s why I wrote the post, because it occurred to me that the unit of production’s MC wasn’t the cost of labour. I tried complaining about the dishonesty of the vendors to my flatmates but they told me to stop being such a nerd, so I brought it to the appropriate forum :)

  • http://www.tvhe.co.nz Matt Nolan

    @rauparaha

    It would be more accurate to say that I agree with you – as you enlightened me :)

    How could your flatmates call you nerdy when discussing economics – I’m lost. I thought all the ladies loved discussions surrounding the pricing structure of firms facing exogenous shocks?

  • http://www.tvhe.co.nz agnitio

    You may be right, it still smells wrong though:)

    In this situation you can vary capacity quite easily based upon expected demand (Wanring cirular arguments coming up!). The price you set for your meals determines how many meals you sell and therefore how many staff you need to have on.

    I’m just thinking out loud really, you guys are probably right. If I spend more than 2 minutes thinking about this I’m sure I’ll eventually reach the same conclusion you guys have:)

  • http://bradtaylor.wordpress.com/ Brad Taylor

    It seems probable that if it were not for the altered demand conditions allowing them to charge higher prices, many cafes would not find it worthwhile to open on days when average cost is higher.

    I doubt there’s any conscious dishonesty here. My experience is that small business owners don’t think explicitly in terms of the cost and benefit of marginal units as much as in terms of the profitability of additional days or hours open. It’s a cognitive shortcut that will on average result in profit-maximising behaviour. Whenever I’ve talked to people in the hospitality business about surcharges they’ll cite higher labour costs as the reason, saying that it wouldn’t be worth opening if they didn’t charge extra.

    I’d say their thinking goes something like: Should I open today? costs are higher, so I’ll need to charge more or I won’t open. Therefore, it is the higher costs making me charge more. Inelastic demand allows them to charge more, but is not the psychological reason motivating them to do so.

  • http://www.tvhe.co.nz rauparaha

    I’m sure they’re just repeating received wisdom, not consciously lying, yes. But how can they not think abuot demand? If they raise prices on a high cost day where there isn’t a different demand schedule then they’ll make even bigger losses. They must take it into account in some fashion.

  • http://www.tvhe.co.nz Matt Nolan

    @agnitio

    Yes it is true that you set capacity based on expected demand – but if expected demand is no different, and the marginal cost of production once capacity is set is the same then this shouldn’t impact on prices.

    It will impact on the decision on whether to open for each hour of the day – but it can only impact on prices through demand.

  • http://www.tvhe.co.nz Matt Nolan

    @agnitio

    Think of it this way – capacity is set PRIOR to selling the meal. So it is really just like capital.

  • http://www.tvhe.co.nz Matt Nolan

    @Brad Taylor

    As long as we have effective competition I think we have to base any increase in prices on the basis of demand – even if we have rule of thumb firms.

    If the individual firms have any ability to influence each others demand then we could view this decision rule as a way to enforce collusion.

    However, either way this is all about demand. If firms were fully competitive and no shops were shut down, then the additional labour cost wouldn’t find its way into prices UNLESS the stores on the margin decided not to open.

    We don’t need the firms to make conscious decisions on the margin for this to happen – as it is the nature of competition to drive individuals towards this sort of outcome.

    Stating that the firms make an irrational decision based on an easily fallible rule of thumb once a year seems like a bit of a straw man to me – once we go down that road we can really throw a lot of decision theory out of the window.

  • http://bradtaylor.wordpress.com/ Brad Taylor

    @rauparaha
    I’m sure they would think about demand if it became highly relevant. Most cafes don’t open on Christmas day, because costs are higher and demand is lower (though, I would suspect also less elastic). In this case there would be the additional thought “but wait, nobody is going to come, so I won’t open.”

    I can’t think of a day with normal demand conditions but higher costs.

  • http://mikee.mashupmafia.com MikeE

    Pretty simple really.

    Higher demand, less supply and the customers are prepared to pay more. If customers weren’t prepared to pay more, it wouldn’t be worthwhile would it ?

  • http://www.tvhe.co.nz Matt Nolan

    @MikeE

    Indeed, so at a firm level this equals higher demand + higher demand (as market supply is lower – so there are more consumers wanting to buy off the open firm).

  • http://billbennettnz.wordpress.com Bill Bennett

    Where I live one local cafe was open over the weekend and did NOT charge any extra. Another nearby cafe was closed and a third started off with a surcharge, but that was ditched by the end of the long weekend.

    The non-surcharge cafe was busy (actually too busy, but that’s another story all weekend). The close cafe didn’t make a penny. The surcharging cafe seemed to operate as an overspill for the busy cafe — with fewer than usual customers and a lower slice of the business available — until it saw reason.

    Now aggregate this across the city and the sensible (non-charging) strategy quickly becomes obvious.

  • http://billbennettnz.wordpress.com Bill Bennett

    Also of note. The big fast food chains Macdonalds etc, don’t operate surcharges. Presumably someone at HQ has crunched the numbers and realised it makes sense not to.

  • Moz

    The cafes I saw definitely suffered capacity constraints – there were queues surcharge or no surcharge. Same with accommodation, Easter is the time to see who needs to buy a new “no vacancy” sign. Since most of them can’t sell more product, it’s obviously time to raise prices. The alternative, of increasing capacity costs a lot and when it’ll only be used a few days a year it’s going to have a very high marginal cost. perhaps that explains some of the surcharge… 10% of the seats are only used at Easter.

  • Hone

    The decision variable in question – the main output variable that is truly controllable for the average outlet- is time: whether or not to open, what time to open/close, how quickly you can turn a table over. Definitely not meals. Who actively controls the number of meals they serve on an intra-day basis with the exception of the very trivial “lets stay open 30 more minutes seeing as table 8 just walked in” which could be seen as taking out an option on a couple of extra meals although not the same as controlling the number of meals? Not to mention I have no idea what a “meal” is but if you mean per-head spend this is a random variable with high variability especially w.r.t time.
    You can control the number of staff employed too but the fact that costs went up doesn’t miraculously increase productivity so only the very stupid would lower FTEs. Increasing FTEs would hardly seem to be the optimal decision as the marginal cost of an FTE increased thanks to govt regulation.
    Deciding whether or not to open is a big call. Before the labour cost increased through government regulation a cafe or restaurant owner would have already figured out how many trading days were needed to cover their overheads (based on assumptions about average variable costs and expected income). Losing a trading day is not trivial. More to the point, trying to forecast earnings to see if you’ll cover the cost shock is a pretty big ask. So for most shutting was a stink plan. So prices went up and I agree that indicates that there are capacity constraints on public holidays. Although it doesn’t definitely mean there are capacity constraints. It could just be a herd effect in which case the supply side of the market may well undergo a rapid opinion shift from surcharges to no surcharges at some point. Following that a few places will go under and there will be fewer outlets than there otherwise would have been and over time the price of eating out will have increased. And everyone is better off?
    The question I have is why anyone would care about the surcharges. (De facto) Sector-specific and time-specific cost impost should result in sector-specific and time-specific increases in prices. Shouldn’t it? Why do punters mind paying extra for something that costs extra?

  • What would Hayek say

    There is a story of differential pricing – not unlike going to a coffee shop were you can order 5 sizes of coffee and multiple flavours all for a different price, when the marginal cost of the next size is only 1 cent but the price charged is 20 cents (equals a nice 19 cents profit). What the cafe is doing is enabling you to depart with your income because “you feel special” by eating there on a public holiday.

    Now if there was more competition then, maybe you would not see such a significant level of price differential, but then since it is a repeat game dependent on the original starting conditions (govt regulation) the first step was to add a price differential and now there would be strong incentives on all participants to maintain the differential (cartel behaviour). The question would be what size of change in the game is required for the incentives to move from cartel to competition. At the moment I suspect profits from the cartel compensate against any incentive to compete.

  • What would Hayek say

    Ps the first part of above was mostly borrowed from Tim Harford and his book “the undercover economist”.

  • http://www.tvhe.co.nz rauparaha

    @What would Hayek say
    I think you’re talking about price discrimination, which is essentially what we concluded above. We referred to it as a different elasticity of demand over Easter due to the closure of competing outlets, but it’s the same thing. I’m not sure about the cartel behaviour, though. It’s not necessary to assume that to get the higher prices, and I think it would be hard to sustain in the cafe market due to the ease of entry.

  • http://www.tvhe.co.nz rauparaha

    @Hone
    I disagree. The product sold and priced by the restaurant is a meal. They control the quantity sold the same way any business does: through the price. Customers pay for food consumed, not time spent in the establishment. Pricing strategies depend on marginal costs and revenues, which are not influenced by labour costs. An explanation based on price discrimination and changes in demand over Easter is far more convincing since it draws on a change in marginal revenue to explain the price increase.

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  • insider

    Go back to when these new wages were introduced. There was a big PR exercise by the hospitality industry representatives to talk up the need for surcharges. It became a self fulfilling prophecy as most cafes picked up the signal. So it was purely a rent seeking exercise and an attempt to shift the whole market in a cartel like manner.

    The Road Transport Forum does it all the time when diesel prices rise saying it will drive up transport costs and so signalling its members to follow, and when prices fall it then says that charges won;t fall as fuel only makes up a small part of operators’ costs to try and manage customer expectations and price cutting.

    It’s interesting now to see cafe consumers responding and competition emerging.

    PS I don’t think McDs did crunch numbers. Changing prices is annoying and they probably just thought it was too much hassle and too brand damaging.

  • http://www.tvhe.co.nz agnitio

    Customers pay for food consumed, not time spent in the establishment.

    Maybe at McDonalds….

    At an actual restaurant if you sell a meal you would generally expect the guest(s) to stay for a certain amount of time.

    I accept the demand side story you guys are telling, I just think you are too quick to write off the possible supply side aspect, even if it is is a relatively small part of the reason we witness high prices on public holidays.

    My local curry restaurant offers much cheaper prices for take away meals. The unit production cost of this meal is the same as if I dine in yet they offer a much cheaper price. Sure, part of this is likely to be price discrimination given that people who want takeaway meals will generally be more price sensitive, but part of it could also be due to the fact that the restaurant doesn’t need to employ a waiter to look after you for the next 40 mins.

    Having worked in hospo for a while I have seen plenty of situations where willing customers have been kicked out of the bar (not because it’s too late or they are too drunk!) because the revenue from drinks they are purchasing won’t cover the bartenders wages for another hour. Given that over this increment the bartenders wages are avoidable the bar shuts. On your logic the bartender is a fixed cost and since the price of a beer exceeds the marginal cost the bar would stay open since they are making a contribution to fixed costs.

    Obviously my examples are of some fairly specific marginal situations. Do these justify a full 20% price increase by themselves? probably not.

    I’m fairly convinced now that the demand side story is probably the main explanation, I just think the way service based restaurants price and view the incremental nature of their cost structure is quite different from McDonalds which more closely resembles a factory…

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