Many months after passing CORe, and believing I forgot everything I had learned, I was looking for something quick to eat for lunch before a meeting. “What do you want?” my friend asked as we were stepping out. “A falafel sandwich,” I replied. Now, anyone who has walked on Fulton Street will tell you that with Wall Street a few blocks ahead and the World Trade Center a few blocks behind, Fulton Street hosts some expensive restaurants (who have fixed prices and inordinate service charges). “How much are you willing to pay for it?” my friend asked. “Less than ten dollars,” I responded nonchalantly. I mean $10 for lunch, that’s generous. She deftly swerved me toward the food trucks.
I had just moved to New York City from Washington, D.C., and food trucks in the capital are almost as expensive as the local delis. Expecting the same here and dreading breaking the bank, we reached the food trucks. There were three, and counting from a distance I called them A, B, and C. “Which one sells falafel?” I asked. After we had walked past all of them, we realized there was stiff market competition. Each truck, at the outset, seemed to be selling absolutely identical food. Well, except for Truck C who was offering people a mango pickle to go with their biryani (what!). There were also two other trucks a block away on either side selling a different variety of ethnic food, but I was intrigued by what I saw here. These trucks were barely a few feet away from each other, so surely they were differentiating in some way? I decided to survey.
“What do you want?” asked the owner of Truck A. “How much for the falafel sandwich?” I asked him in reply. Truck A sold it for $6, B for $4, and C for $8. They sold them with identical ingredients. The only reason to differentiate now would be the taste, and I had no idea which one tasted better. These guys, it seemed, were bad at differentiation. Shifting inward on my demand curve, I went to B and ordered one for $4.
While I was waiting for my sandwich, and watching my friend bargain for a single cigarette with a fellow customer (honestly who does that?), I pondered the inevitable question: Who’s making the most money here? Also, working for the Federal Reserve, I can tell you that the cliché “markets don’t lie” is true. The other two trucks survived in spite of selling something at a higher price, and I began to wonder: How are they doing it?
I tried to answer these questions by watching their customers. A constant barrage of people went straight to the truck they preferred and gave their very precise orders. That tells me these owners had regular customers who knew exactly what they wanted. That prompted another question: Is it demand or supply that is influencing the prices here?
Before I could investigate, my friend returned and demanded her sandwich. I told her to avoid Truck C, and that Truck B was cheaper, but Truck A was closer, so she had to choose. She went straight to Truck A, and said, “I got the same sandwich with the other guy for $4. Can you give it to me for $4?” He did. I was both amazed and furious. Well if he could sell it for $4 why wasn’t he? Wasn’t he losing customers?
It’s not so simple. If you look closer, it turns out Truck A’s fixed costs are higher Than B’s because A sold food items made out of more expensive raw materials. B meanwhile sold many low priced products and kept his fixed costs lower. Therefore, A could afford to give a discount to one customer because he had already incurred sunk cost, but he could not entirely reduce the price because doing so would mean lesser revenue to cover his accounts payable, reducing his profit. Thus, he used first-degree price discrimination to gain my friend as a customer while swallowing the marginal cost. Here demand decided the price.
Truck C, on the other hand, was still selling biryani with mango pickle (by the way never trust a guy who sells you biryani with mango pickle). He had ten other sauces for his rice salad (I now refuse to call it biryani), and his business was roaring. This is because his customers genuinely feel the effects of horizontal differentiation; he could swing high prices for his services. Seriously that dude can sell anything!
So there, I concluded: “These owners are still in business by creating unique supply and demand curves for their businesses through horizontal differentiation.” It was also then I realized by how much CORe had expanded my understanding and observation. I can now grasp the dynamics of market forces intuitively and make my decisions in a more sophisticated manner. HBX and Professor Bharat Anand did an incredible job not only keeping me involved with the learning, but also inspiring me to explore the world using the concepts they taught. I am very grateful to them, as well as my fellow cohorts who continuously simplified economics for me so I “got” it in such a way that the course concepts have remained with me to this day.
The next day, hoping his sandwich was better, I went to Truck A and asked, “How much for the falafel sandwich?” “Five dollars,” he replied. And from the day after that, the price remained at six. I’m tempted. Do you think I should bargain?
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