MODULE NAME: Economics for Managers (BAM020-2018-APR)
STUDENT REFERENCE NUMBER: 180137356
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ABSTRACT-
This document discusses the price war between Burger King and McDonald’s. The discussion is based on an excerpt from Bloomberg dated January 12, 2015. The document highlights the market structure in which the two competitors are operating, it also evaluates why such competition drives down prices for consumers and why the price ends up lower than an equilibrium price. It also covers a brief suggestion of ideas on how McDonald’s can increase their sales.
HISTORY-
Burger King Corporation, was founded in 1953 as Insta-Burger King, a Jacksonville, Florida-based restaurant chain. After Insta-Burger King ran into financial difficulties in 1954, its two Miami-based franchisees David Edgerton and James McLamorepurchased the company and renamed it “Burger King, which successfully ran as an individual entity for eighty years before selling the company to Pillsbury Company in 1967. The most prominent restructuring by Pillsbury’s management came in 1978 when Burger King hired McDonald’s executive Donald N. Smith to help revamp the company. In a plan called “Operation Phoenix”,4:118 Smith restructured corporate business practices at all levels of the company. Changes included updated franchise agreements,5 a broader menu4:1195:66 and new standardized restaurant designs. Smith left Burger King for PepsiCo in 19806 shortly before a system-wide decline in sales. However, the company soon started declining and was overtaken by British company Grand Metropolitan PLC.
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Burger King’s menu has expanded from a basic offering of burgers, French fries, sodas, and milkshakes to a larger and more diverse set of products. In 1957, the “Whopper” became its signature product. The company went public in 2002.
QUESTIONS-
Discuss the type of competition here.
Both Burger King and McDonald’s are leading fast-food chains with markets spread across the United States and internationally. They are among the few fast food brands operating internationally in lines of KFC, Taco Bell, Wendy’s etc. Since the international fast food chain is characterized by the dominance of few large firms, the price war between Burger King and McDonald’s represents competition in an oligopolistic market structure.
Why does such competition drive down prices for consumers? Explain why the price ends up lower than an equilibrium price.
The excerpt states that Burger King sold 10 chicken nuggets for $1.49 which was about about half the regular price of $2.99. This initiative was to compete with Mc Donald’s who sold 50 Chicken McNuggets for $9.99, or 20 cents per nugget. The price war was started by Burger King to gain a greater share of the market and lower prices mean a better deal for the consumers. In an oligopoly market firms are independent regarding decisions on price and output.Hence if any one of the firms raises the price of a particular commodity, consumers tend to buy from other available firms which are offering cheaper prices. Similarly if any one of the firms lowers the price of a particular commodity, consumers tend to drift away from other available firms which offer similar commodities. However in real world, in an oligopolistic market if one firm lowers price of its products competing firms start offering attractive discounts or cutting prices as well in order to prevent losing customers. Such competition results in a price war and companies usually need to lower their profit margins. Price war proves to be a bonanza for consumers as they get cheaper deals from the few available firms in the oligopolistic market. Price conscious consumers would turn to Burger King due to the super cheap offer and the change in demand can be seen as a movement along the demand curve as shown in Fig. 1.1. Hence it can be rightly said that price war benefits consumers since purchasing power is increased. However , price war can also have a negative impact on the consumers in the long run. Excessive price cutting can kick a firm out of the market due to very low profit margins which enables other firms to increase their price of commodities resulting in reverse movement along the demand curve to the original position and consumers would eventually have to pay more.
Calculation of equilibrium price and movement along the demand curve is as shown below.Initial demand equation for burger king considering 10 nuggets for $2.99 and Mc Donald’s per nugget as 20 cents assuming any other factors as irrelevant.
Burger King
Price per 10 nuggets (P) 2.99$
Assuming 1000 nuggets are sold in a day at a particular storeIncome per day = 2.99$ *100 = 299$
Income per month = 299$*30 = 8970$
Mc Donald’s
Price per nugget= 20 cents
Price per 10 nuggets (PMcD) 2$
Assuming 1000 nuggets are sold in a day at a particular storeIncome per day= 2*100 =200$
Income per month (Y) = 200$*30 =6000$
DEMAND FUNCTION ( QD) = 104-40P +(20*PMcD) + (0.01*Y)
= 104-40P + (20*2) + (0.01*6000)
= 204-40P
SUPPLY FUNCTION (QS) = 58+15P (Considering other factors such as such as wages, transportation as constant)
At equilibrium , quantity demanded is equal to quantity supplied.
Hence QD= QS
204-40P = 58+15P
P = 2.65
Equilibrium price per 10 nuggets = 2.65$
Equilibrium quantity per day = 204-40P
= 98 nuggets
Final demand equation for burger king considering 10 nuggets for $1.49 and Mc Donald’s per nugget as 20 cents assuming any other factors as irrelevant.
Burger King
Price per 10 nuggets (P) 1.49$
Assuming 1000 nuggets are sold in a day at a store
Income per day = 1.49$ *100 = 149$
Income per month = 299$*30 = 4470$
Mc Donald’s
Price per nugget= 20 cents
Price per 10 nuggets (PMcD) 2$
Assuming 1000 nuggets are sold in a day at a store
Income per day= 2*100 =200$
Income per month (Y) = 200$*30 =6000$
DEMAND FUNCTION ( QD) = 104-40P +(20*PMcD) + (0.01*Y)
= 104-40P + (20*2) + (0.01*6000)
= 204-40P
SUPPLY FUNCTION (QS) = 58+15P (Considering other factors such as such as wages, transportation as constant)
At equilibrium , quantity demanded is equal to quantity supplied.
Hence QD= QS
204-40P = 58+15P
P = 2.65
Equilibrium price per 10 nuggets (Pe) = 2.65$
Equilibrium quantity per day per 10 nuggets (Qe) = 204-40P
= 98 units
At the equilibrium price Pe supply and demand remains at Qe .Now due to change in the price of nuggets there would be a change in the quantity demanded by the consumers which will result in a movement along the demand curve. Quantity demanded will rise due to which there would be an increase in supply which will cause the price to decline.
As shown in the graph below, quantity demanded changes from (Qe) to (Q1) due to which supply curve shifts downward from S to S1 and price falls below the equilibrium price from Pe to P1. Equilibrium point falls from e to e1 as the quantity tends to shift from Qe to Q1 and the quantity supplied at equilibrium shifts from Q2 to Q1, ultimately making Q1 the new equilibrium quantity and P1 the new equilibrium price.
https://www.investopedia.com/financial-edge/0810/the-pros-and-cons-of-price-wars.aspxhttps://www.coursera.org/learn/principles-of-microeconomics/lecture/JGfog/equilibrium-price-effects-of-supply-and-demand-curve-shifts-price-controls-and
