How is it possible that a chain like McDonald’s, whose food is less than what most consider quality, can be a dominating force in the market? How is it possible that a restaurant can charge over fifty dollars for a steak and ten dollars for a glass of wine and have customers glad to pay it? It is a cultivation of principles of economics, namely supply and demand. When these principles are applied to a restaurant in the proper manner, that is to say all aspects of a restaurant have been assessed and an appropriate decision is made upon the assessed information, a profit is bound to accumulate.
A comprehension of simple concepts of economics is crucial in understanding how they affect a business for better or for worse. Since supply and demand are the main concerns of restaurant owners, their evaluation will reveal a great deal about the economics behind their decisions.
Demand is the amount of a good or service that consumers are willing and able to buy at a certain price (Billings 111). Say there is a product called a widget that normally sells for ten dollars. If we were to move the price up from ten dollars to twenty dollars, the demand for the widget will lessen because the consumer is not willing to pay or is not able to pay that amount. Conversely, if the price were to drop from ten dollars to five dollars, the demand would increase as more are able and willing to make a purchase. A simple demand curve illustrates the demand schedule.
Figure 1: Demand Schedule for Widgets
The demand can shift completely without a change in price. Say that people never have seen a widget but upon purchasing one, they fall in love with them. This causes the demand to increase as more people want widgets simply because they are great. This would cause the curve in the above demand schedule to shift to the right. On the opposite end, the curve can shift to the left; that is the demand is lessened without any change in price. Say widgets are too much of a hassle to own and people just don’t purchase them. All points on the schedule shift to the left.
Figure 2: Demand Schedule Shifts to Both the Right and Left
Now obviously, the demand is affected by other factors. People will not keep buying widgets at one price. The law of diminishing marginal utility states that people do not necessarily want more and more of the same product at a constant price if, sooner or later, the satisfaction (utility) of each additional unit becomes less and less (Schwartz 179). Applying this rule to widgets we can see how if a widget were to be two dollars, the demand would be overwhelming. Everyone could attain a widget and use one. However the widget would lose their utility and therefore their demand would lessen. Another way everyone could attain a widget would be if the income of a population were to increase. With more money, more goods can be bought; a shift in the demand schedule to the right.
Finally we can address the elasticity of demand. The elasticity of demand is the measure of the degree to which the quantity demanded for a good or service will change when price for the same good or service changes. In other words, the shift in demand as widget goes from ten dollars to twenty dollars. To get a better view of the idea of elasticity, look at the graph below. We see two different demand schedules for widgets. The curve labeled W1 has a steeper slope and therefore is less elastic than W2. The demand does not shift as much with a varying price. Curve W2 on the other hand has a greater variance in response to price changes.
Figure 3: Elasticity of Demand in Widgets
With a foundation in the principles of demand, we can now move on to supply side economics. Supply is the amount of goods and services producers are willing and able to offer for sale at a certain price (Billings 118). Say our wonderful widget is in high demand by the public, the natural tendency for the producer is to increase the price to gain more money. Similarly, if the demand were low, the supplier would offer widgets at a lower price. In short, since not many want widgets, not many widgets are going to be supplied. The supply schedule illustrates this concept. Notice it’s a mirror image of a demand curve.
Figure 4: Supply Schedule for Widgets
A shift in supply can happen without a shift in price just as a shift in demand can happen without a shift in price. Say the cost of producing a widget is reduced; technology has advanced and producing is now easier and quicker. The supplier can now supply more widgets at their given prices so the supply curve therefore shifts to the right. Now say the cost to produce each widget increases. The producers are willing to supply less because they must charge a higher price for each widget but at the same time do not want to lose their customers.
Figure 5: Supply Schedule Shifts to Both the Right and Left
Other factors affect supply. Say for instance an increasing supply of widgets needs to be kept warm to be kept in tact. Products like blankets, scarves, gloves will be in higher supply so long as the supply for widgets is increasing. This relationship is good for accessory suppliers because their mother product, the widget, needs these satellite suppliers to help them survive.
Supply and demand meet together in the marketplace at an equilibrium point. This point is where the amount sellers are willing to supply equals the amount consumers are willing to buy (Billings 123). By looking at a supply curve superimposed on a demand curve we can see the equilibrium point. Coming to this equilibrium point can be complicated. At twenty dollars per widget, the suppliers are willing to supply many, however the buyers are only willing to purchase few. This produces a surplus, or extra amount of goods left to be sold. Equally, at five dollars per widget, the buyers are willing to purchase many while the suppliers are willing to supply few. This produces a shortage; there’s not enough product to satisfy the consumer.
Figure 6: Supply Schedule Meets the Demand Schedule for Widgets
Now that a basic understanding of supply and demand has been established, a look at their nature in the real world can occur. When picking a spot for a restaurant, there lies in the mind of the owner the proverbial “location, location, location”. The location of a restaurant is such a fundamental and key principle that when not completely understood by an owner, the restaurant can fail.
A crucial part for any restaurant owner is to know the location inside and out. In talking with Mr. Tomas Mahoney, manager of MacArthur Park, a local restaurant, the importance of location was revealed. MacArthur Park lies just north of the train station in the town of Rockville Centre. It can easily be seen by train farers, who if hungry, can easily stroll to the restaurant to get a bite to eat. Furthermore, knowing the local sports leagues, whose players after long games like to get food, is helpful for business. Because of these leagues, restaurants stay open later in the summertime thusly allowing their demand for goods to increase. Other cases in which the hours are used to expand the demand are on weekdays where the restaurants in town open for 11:30 lunch for the local businesses (Mahoney).
The affluence of an area can greatly affect the demand and demand pricing. A more affluent neighborhood would undoubtedly be able to pay more for their meals and thusly can be asked for more. The shear fact that they can afford to go out and eat is essential. Great chains like McDonalds do not have universal pricing across the United States. As you travel from location to location, there is a noticeable difference in the pricing of their products depending on the general wealth of an area.
This is due to the fact that in different areas, people are willing to pay different prices for their meals and so by varying prices, McDonalds tries to achieve an equilibrium point with their customers. MacArthur Park lies in Rockville Centre, an upper-middle class neighborhood whose average earnings of persons with income is one hundred twelve thousand, three hundred sixty nine dollars thusly existing in a neighborhood able to pay for dinner. (Per Capita Income).
In picking a location one must also know the prices of similar restaurants in the area. There can be a great elasticity in your demand depending on one’s peers’ prices not to mention one’s own. It is wise to check the competitions’ prices about once a week. In comparing prices the term used is “apples for apples”. What this means is that in comparing prices of competitors restaurant owners see what the prices are for products of similar quality. One owner cannot compare the price of their fifteen dollar steak to the town’s finest steakhouse that has aged prime beef in their meat lockers.
He can, however, see how much the steakhouse is charging for universal quality products such as their beverages, and, in turn, act upon them. Soda is only ten cents a gallon and generally is of the same quality as it comes from the same supplier (Mahoney). The fact that it comes from the same supplier means that in an area, the cost to supply the product will be the same for all restaurants in that area. This equal quality and cost to supply among the products allows for a more realistic comparison of prices between restaurants.
The number one goal of any restaurant owner is to reach equilibrium points. That is to make the supplies meet the demands in the most profitable manner. There is no universal formula for supply meeting demand and turning profit on all products (Mahoney). For example, beverages, as abovementioned, are incredibly cheap. They undergo the highest percent markup of any product in the restaurant. This percent markup cannot exist for all products though. Imagine applying the same percent markup to a steak as to a beverage. No one in their right mind would purchase that steak because it would cost a small fortune. There would be a huge surplus as the owner would be willing to sell an incredible amount of steak at such a high price while the consumers wouldn’t be willing to purchase that same amount.
In testing the demand for a dish, restaurant owners usually “run” specials on that dish. By running a special you get an idea of how many people particularly enjoy that meal. If the special were to “graduate” to a menu meal, then naturally the amount of people ordering will lessen. This is because the special is usually supplied at a lower price and as a result more people are willing to buy. Restaurant owners understand that the there will be a decrease in demand when a special “graduates” and so “graduation” doesn’t occur unless there is a heavy demand ready to take the loss of demand.
An easy way to achieve an equilibrium point is by offering a catering service for parties and other get-togethers. When a customer comes into the restaurant and sits down to eat there, a portion larger than “for one” is given to them. The restaurant takes a small hit by giving up profit for customer satisfaction as far as filling the stomach. However, when a restaurant caters, they know the exact amount of people attending the party and, in turn, the exact portions they can make for that amount. There is little to no waste in a catering job described Mr. Mahoney. From the liquor package to the chicken parmagiana, there is a calculated amount of food to keep the customer satisfied and optimize profit.
The supply and demand of a restaurant is affected by other factors besides food costs. Having the cliental to serve clearly raises the demand and, equally, the supply. The ambiance is very important to a restaurant. The capitol used to start the restaurant should make the restaurant look presentable. This presentable appearance will attract consumers and hopefully the demand for the restaurants goods. Cleanliness is a quintessential element for all restaurant owners. It is common sense; people would not want to eat from a dirty plate on a greasy table with smudged silverware. Keeping up to date was also a noted element.
As MacArthur Park has a bar, sporting events were needed to be broadcasted from that bar so as to keep the customers at the bar, ordering drinks. When satellite television was introduced into the market restaurant owners invested in it so they could get all the sporting events from the English Premiership Football to the World Series of Professional Baseball (Mahoney). By getting all sorts of sporting events, owners expanded their cliental thusly increasing his demand. From this expanded cliental comes revenues that will hopefully pay off the base salaries of the waiters and cover food supplies not to mention utilities expenses. Any money left over will be profit which, if invested in expanding the cliental, can increase the revenues and profit in a cyclical fashion.
The most obvious way to increase the cliental is to increase the awareness of the restaurant. Advertising is the number one method of achieving this awareness. Because advertising is recognized as the number one method, a large portion of the money made in a restaurant is devoted to advertising (Mahoney). Certain methods of advertising such as running ads in the local newspaper are more effective than radio announcements. It is the job of a restaurant owner to see which the most effective method is and employ it so as to gain the largest amount of customers possible.
When equilibrium points are achieved it is the hope of every restaurant owner that the money grossed will cover the overhead. The overhead is the total cost of running the business, from utility and rent expenses to payroll. If the overhead is not covered, the restaurant will surely fail.
The concept of how restaurant employees get paid is a crucial element to a restaurants success in covering the overhead. Usually, a restaurant’s waiters/waitresses earn minimum wage. Why do they earn minimum wage? This is due to the fact that they get paid gratuity by the consumers of the meals. The majority of their income comes not from their base salary as provided by a restaurant owner but rather their tips made in a night of work. A waiter’s cheap cost thereby allows a restaurant owner to higher them at relative ease with little constraint to revenues. The owner wants to make sure they keep the marginal revenue product of labor equal to or above the wage the waiters receive. Instead of viewing the waiters in terms people in the workforce, look at them as hours of work done. If the hours of work done produce money greater than the wages that are being paid, then the owner is one step closer to covering the overhead.
The next concept involving the overhead is that of buying the goods needed to make one’s own goods. Making a menu that involves easy-to-acquire goods is very crucial. A menu for example will have several different chicken dishes. Each dish is its own kind of meal however their base, chicken can be bought in bulk. What an owner has to do is watch for what meals are most popular; which ones are in the greatest demand.
When an owner finds a “hot dish” he can do one of two things. Raise the price steadily based on the prestige of the meal and hope for an inelastic demand (a greater demand would be phenomenal), or he can ensure that their will be a supply to meet the demand and remain at equilibrium. The natural tendency would be for the owner to be willing to supply more of his “hot dish” at a higher price, however an owner’s market is unpredictable and to supply more than what is being consumed is not desirable. Therefore, the more cautious restaurant owner will make sure there is the supply to meet the demand and a constant price while the more risky restaurant owner will raise the price and hope for the same demand thusly grossing more revenue.
Certain products however can automatically have a raised price. Lobster is a great example of such a product. When lobster is included in a menu it is normally at an extremely high price. This is because lobster is a food of prestige that is in a high demand a good portion of the year. This goes along with the principle that owners will raise the price and be more willing to supply a product that is in demand. The lobster is also priced highly because the cost for the restaurant to receive the product is high. Sometimes the cost for the restaurant to get the lobster is so high that there is very little profit made by selling it. A restaurant that has lobster on the menu at a set price all year long will make different profits. A method employed by restaurant owners is to use the word “seasonal” under the pricing for products like lobster so they can charge an amount that will guarantee them a certain amount of profit.
When a restaurant makes profits, a bevy of options can be taken by the owner. Possibilities include: expansion; improving the current facilities; hiring more skilled staff; buying better products; etc. Each of these possibilities is designed to draw more people into the restaurant. As aforementioned, the more people an owner has coming to the restaurant, the greater the demand for their goods will be.
The demand and supply concerns of a restaurant are so integrated into all main facets that most decisions made by owners invariably affect both the supply and the demand. From maintaining a modern ambience to pricing the meals to keep competitive, the motive remains the same: Gain more cliental and keep them as valuable customers.