January 6, 2008

Coffee Addiction is costly

The Book, The Undercover Economist by Tim Harford is a fascinating yet simplistic way of breaking down economic concepts. The first chapter seems especially practical due to the fact that all businesses want to maximize profits and all consumers want high quality at a low price. The struggle between the two is the interesting part. In the first chapter Harford expresses the significance of location, rent and thinking on the margin. He uses the example of a coffee shop located in a prime spot in the Waterloo train station in London. He demonstrates through his example how this coffee shop due to location makes high profits. Far outselling its competition. The coffee shop is even able to sell its coffee at a higher price and people will pay the extra money because of the convenience of the shop. The best locations are where the major players reside.

What about competition ? The coffee shops that are not able to have the best locations are broken down further into next best location and the margin or the worst location. The coffee shops are all competing for customers and therefore are competing for profits. The coffee shops with the prime locations will make the most profits. Those with the worst locations will also have the lowest profits. The stores with the lowest profits set the margin or the comparable profits. This is key to understanding why businesses will pay more for location. The profits reflect the location of the business.

Businesses will compete for locations which in turn drives the rent of the location up. This also explains why certain locations products are considered more expensive then others. As in the coffee example, the shop with the prime location probably has a higher rent then the shop with the least desirable location, and the product prices reflect the difference. However the price difference is usually not enough to cause people to choose cost over convenience, therefore the prime location will still have higher profits then those in less convenient, noticeable locations.

1 comment:

Douglas Loeper said...

Great essay Megan,

Just adding as a side note and expanding on your observations. The landlords renting the space out to the coffee shops are utilizing their power of scarcity by renting out space to only one coffee shop in that area. This makes that location even more desirable and increases the askable rent. This power of scarcity is then transferred to the tenant and that passes to the customer. It's both the mix of convienance and the tranferred power of scarcity that demands the higher rents. I know that's what the idea of 'location' is, I was just putting what we've learned into this perspective. Again great essay!