McGraw Hill’s

Economics Web Newsletter

Spring Issue, Number 4 of 7 Covering Week of March 13, 2000

Do You Remember

Article Analysis

Note to Instructors

The Economics Web Newsletter is for use as a tool when teaching the principles of economics. It specifically references the Wall Street Journal editions of selected McGraw-Hill Principles of Economics texts. Do You Remember presents five or more quick factual questions and answers covering several articles that have appeared in the Wall Street Journal in the week preceding the newsletter. They make good in-class quizzes when reading the Wall Street Journal is required. Article Analysis reprints one article from the Wall Street Journal and poses five or more analytical questions and their answers with references to text chapters.

The Economics Web Newsletter is written by Jenifer Gamber.

Publication Date: 3/20/00.

©Published by McGraw Hill. All Rights Reserved, 2000.

 

DO YOU REMEMBER?

If you have read the Wall Street Journal from March 13th to March 17th, you should be able to answer the following questions based upon important articles relating to economics. The reference at the end of the answer tells you the date and page number where you can find the article upon which the question is based.

  1. For every $3 lent by banks in China in the past three years, by how much did output rise? (a) $2, (b), $4, (c) $6, (d) $8. Click for answer.
  2. Compared to 1989, did U.S. companies announce more or fewer employee layoffs in 1999? Click for answer.
  3. What threatens to keep the U.S. farm belt in a recession for the third consecutive year? Click for answer.
  4. What has happened to oil prices in the past few months? How is OPEC responding? Click for answer.
  5. What recently announced merger is affected by a federal rule that doesn’t allow the same company to own the daily newspaper and a television in the same city? Click for answer.
  6. What is greater: the gap in income between races or the gap in wealth? Click for answer.
  7. Approximately what percentage of household wealth is accounted for by holdings of stocks? (a) 10%, (b) 30%, (c) 50%, (d) 70%. Click for answer.
  8. According to the National Association of Purchasing Manager’s survey, what is the biggest threat to the business environment today? Click for answer.
  9. Name one of the provisions of the Chinese Trade accord from the following areas: tariffs, securities, telecommunications, films, or textiles. Click for answer.
  10. Have consumers slowed purchases as a result of the Fed rate increases and increases in energy prices? Click for answer.
  11. The price of Human Genome Sciences (HGS) shares rose upon the announcement of what patent? Click for answer.
  12. What has hurt U.S. aerospace and military exports recently? Click for answer.
  13. What trade statistic hit a record in 1999? Click for answer.
  14. What two factors pushed up producer prices by 1% in February? Click for answer.

 

ANSWERS TO "DO YOU REMEMBER?" QUESTIONS

  1. A survey by the central bank in China showed that for every $3 lent (mainly to state enterprises), output rose by only $2. (See "Under Pressure, China Blesses Private Sector" March 13, page A1.)
  2. U.S. companies announced 675,000 layoffs in 1999 compared to only 111,285 in 1989. Many companies are hiring employees and firing employees at the same time to retool themselves for an ever-changing economy. (See "Zero-Sum Gain: In this Expansion, As Business Booms, So Do the Layoffs" March 13, page A1.)
  3. Drought. (See "U.S. Farm Belt Is Threatened by Drought" March 13, page A2.)
  4. Crude oil prices have nearly tripled since last year when OPEC decided to cut production by 5 million barrels per day. OPEC is discussing increasing production by 1 million barrels per day. (See "OPEC Is Moving Toward Agreement To Raise Oil Output" March 13, page A2.)
  5. The acquisition of Times Mirror Co (of Los Angeles) by Tribune Co (of Chicago). The combined company would own both TV stations and newspapers in LA, NYC and Hartford, CT. (See "Tribune Co. Deal Puts Cross-Ownership Rule In the Cross Hairs," March 14, page A1.)
  6. The gap in wealth is much bigger. For example, median wealth for African-American, Asian and other minority families was less than one-fifth the median wealth for white families. The comparable statistic for income is about 62 percent. (See "U.S. Racial Wealth Gap Remains Huge" March 14, page A2.)
  7. b. 30 percent, a historic high. This due to the rising number of households owning stock and the rise in stock prices. (See "Stocks Are Almost a Third of Household Wealth," March 14, page A2.)
  8. Rising energy prices. Go to www.napm.org for the full report. (See "Manufacturers Expect Slower Economy as Energy Prices, Interest Rates Rise" March 14, page A4.)
  9. Tariffs on industrial products would fall 9.4% by 2005; foreign firms would be allowed minority ownership of securities-funds; foreign firms would be allowed 50% ownership of telecommunications ventures; import restrictions of foreign films would be raised from 10/yr to 40/yr; textile quotas would be phased out by 2005. (See "Gore to Lobby for Chinese Trade Accord," March 15, page A2.)
  10. No. Excluding gas purchases, retail sales rose an unexpectedly high 0.7 percent in February Go to www.doc.gov for the full report. (See "Retail Sales Rise an Unexpectedly Strong 1.1%," March 15, page A2.)
  11. HGS received a patent for the gene that the AIDS virus uses to infect a cell. (See "Genes Are Patentable; Less Clear Is if Finder Must Know Their Role," March 16, A1)
  12. Increased U.S. review of aerospace sales for security conflicts has increased the time of review of such sales contracts by 30 percent. (See "Regulations Stifle U.S. Aerospace Sales" March 16, A2)
  13. The current account deficit rose to $338.92 billion in 1999, a rise by 50 percent from 1998. Go to www.bea.doc.gov for the full report. (See "Key Trade-Deficit Measure Sets a Record," March 16, A2)
  14. Gasoline prices rose 7.5% in February and cigarette prices rose 6.3%. Without those increases, the PPI rose very little. Go to stats.bls.gov for the full report. (See "Producer-Price Report Is Inconclusive," March 17, A2)

Return to Questions

 

What Do Restaurants
Really Pay for Meals?

By EILEEN DASPIN
Staff Reporter of THE WALL STREET JOURNAL

3/10/2000
The Wall Street Journal
Page B1
(Copyright (c) 2000, Dow Jones & Company, Inc.)

Dining in the fall at Quilty's, a stylish New York restaurant, Jaime Wolf knew something about his $23.50 pork chop was bothering him. When he looked at his plate, he realized what it was: The price.

"The food was good, but it didn't seem good enough to match the price," recalls Mr. Wolf, a lawyer. So how much did his meal cost the eatery? About $6.25.

So it goes with entree economics. As any diner can't help but notice, it isn't just the quality of the cuisine that is rising in these booming economic times. The tab is, too. Indeed, the average menu price rose 13% during the past five years -- edging out inflation and far outpacing the rise in wholesale food prices. In some hot spots such as New York, Los Angeles and San Francisco, even the once-untouchable $50-a-plate barrier has finally been shattered.

All of which prompts us to set down our forks and wonder: What do restaurants really pay for the stuff on our plates? Weekend Journal decided to dine out -- and find out. We talked to food consultants, restaurateurs and chefs, and deconstructed the prices on dozens of dishes, from the persimmon salad at Pinot Bistro in Studio City, Calif., to the filet mignon at Charlie Palmer Steak in Las Vegas.

Some of what we discovered was a bit hard to swallow. For one thing, the conventional wisdom has always been that restaurants get you on the liquor -- and indeed, they typically charge five times more for whiskey and wine than they pay for them. But certain kinds of foods have even more staggering markups. Mussels turn out to be one of the biggest cash crops -- with markups of as much as 650% -- and if you are a vegetarian, the price multiples on your entrees are so high you basically are subsidizing the carnivores around you.

  1. What is a reason an economist might suggest for why vegetarian meals have a higher mark-up compared to meat dishes?

    But the biggest sticker shock of all may be on a big pink fish. Farm-raised salmon -- referred to in the trade as "the chicken of the sea" -- could well be the food industry's best-kept secret. It costs just $2.50 a pound wholesale and is often priced at a whopping 900% markup or more. "People think it's an elegant dish," says Brian Buckley, director of management studies at Peter Kump's New York Cooking School. "They don't think about it being farm-raised. They see the bears swiping at it as it goes upstream on a National Geographic special."

    At the popular New York eatery Docks, a 10-ounce portion of grilled salmon with coleslaw and potatoes is $19.50. Actual cost of the ingredients? $1.90, the restaurant says.

    To be fair, focusing on the cost of a restaurant meal's raw ingredients is like calculating the value of a Picasso based on the cost of the paint.

    When we eat out, we also are paying for labor, atmosphere and overhead. Restaurants need to make a profit just like any other business. "We are not the Red Cross," says Eric Ripert, the chef and co-owner of Le Bernardin, a high-end seafood restaurant in New York. "What's the point if we're not making money?"

    Le Francais, Wheeling, Ill.
    Trio of Lamb (Mustard-crusted rack, cumin-dusted loin and braised shoulder with their own jus)
    Total Cost to restaurant: $16.81
    Menu price: $32.50

     

    Boiled down, there's a simple rule of restaurant finances that explains all this -- and can help you eat more for your dining dollar. Call it the 300% solution. Many independently owned restaurants, from the fanciest boite in Boston to a barbecue joint in Dallas, aim for an overall food markup of 300% -- or four times -- the cost of the raw ingredients. (Any less, and the restaurant might not turn a profit, food consultants say.) But some ingredients -- especially prime cuts of beef and gourmet seafood such as day-boat scallops -- cost the restaurant so much that diners wouldn't tolerate such a high markup on them. So, since restaurants can't ratchet up the rates enough on those items, they have to make it up on the cheap stuff, such as salmon, lettuce and pasta.

  2. What costs other than raw materials do restaurant owners face? Which of those costs are relevant for the pricing decision?
  3.  

  4. Does a common 300% market suggest that the restaurant market is monopolistic or competitive? What additional information would you need to make that decision?
  5. Where the Beef Is

    The Sunset Grill in Nashville, Tenn., is a case in point. Its best-selling Angus Beef Tenderloin costs the restaurant $7.42 for the meat, 75 cents for the greens and potatoes, and 25 cents for the sauce, for a total of $8.42. Few diners in town would pay the target 300% multiple for that dish, or $33.68. So instead, the restaurant lists the tenderloin at $25, or just short of a 200% markup. But to even things out and hit its overall 300% target, the eatery boosts the price on its Grill Vegetable Plate -- $1.55 of rice, beans and vegetables -- to $9, close to a 500% markup. "I personally would rather sell nothing but pasta and vegetables," owner Randy Rayburn acknowledges.

     

    Figuring Out the Tab

    We asked six restaurants to tell us the ingredients of one of their entrees, and what they cost the restaurants wholesale. Then we bought the ingredients at the grocery store. The results:

    Restaurant

    Dish

    Menu price

    Grocery store price

    Wholesale price

    Carmine's
    New York

    Zuppa di mussels

    $12

    $3.15

    $2.25-$2.50

    Ingredients: 1 pound mussels with tomato sauce

    Heaven on Seven
    Chicago

    Grilled Louisiana Gulf shrimp and Andouille sausage on bed of white rice (comes with a choice of cup of soup, gumbo or salad)

    $18.95

    $9.00

    $6.39

    Ingredients: 6 shrimp (about 6.5-7 ounces), 2.5 ounces andouille sausage, 6 ounces white rice, plus sauce and seasoning, and 1 cup of soup

    Grill 23 and Bar
    Boston

    Grilled swordfish

    $24.50

    $9.00

    $4.50-$7.50

    Ingredients: 12 ounces swordfish

    Docks
    New York

    Grilled tuna with steamed red potatoes and coleslaw

    $20.50

    $8.15

    $6.55

    Ingredients: 10 ounces tuna, 8 ounces potatoes, 5 ounces coleslaw

    Pinot Bistro
    Los Angeles

    Farm chicken with a roasted garlic glaze and Pinot fries

    $15.95

    $3.00

    $4.08

    Ingredients: 12 ounces chicken, 10 ounces french fries

    Tennessee's Real BBQ Real Fast
    Framingham, Mass.

    Slab of Memphis ribs

    $18.95

    $11.60

    $5.94

    Ingredients: 2.25-2.5 pounds of pork ribs, 5 ounces cucumber salad, 5 ounces beans, cornbread, sauce and seasonings

     

  6. If the same food at a restaurant is so much more expensive than the same food at a grocery store, wouldn’t it be more rational not to eat out? Why or why not? Using the table above, what is the value added that the restaurant contributes to the economy for each dish?
  7. Consider also Charlie Palmer Steak in Las Vegas. The restaurant charges $27 for an 11-ounce filet, for which it pays $9.50 -- a relatively skimpy markup of less than 200%. But it makes a bundle on vegetables and side orders such as the $7 steak fries (which cost the restaurant 65 cents a portion -- or a 977% markup). "The steakhouse mentality is that a steak is a steak," says chef-owner Charlie Palmer. "You want sauce on the side? That's $8. You want a potato? That's $5. And no one says a word." In fact, before he opened the restaurant, Mr. Palmer estimated the average tab per diner would be $56; instead, because the side dishes are so popular, it is $73.

  8. What does the differing markups suggest about elasticity demand for various restaurant foods? Why doesn’t the Sunset Grill sell just pasta and vegetables at a 900 percent mark up?

Some patrons do see through a restaurant's smoke and mirrors. Dining at Nashville's upscale Wild Boar in January, Amy Smotherman ordered a $7.95 "Pyramid of Micro-Mesclun & Artichoke Hearts in a Verjus Vinaigrette with Basil Oil" as an appetizer. Because Ms. Smotherman runs a church kitchen, she knows something about food prices. "That lettuce didn't cost them 25 cents," she says. "It wasn't even an ounce of salad."

Abby Benrahmoun, maitre d' at the Wild Boar, concedes "the mesclun salad looks small" but says the dish is labor intensive. "Altogether it's a 45-minute production from scratch," he says, including making and frying the pyramids, boiling and coring the artichokes, and decorating the plate with saffron, squid ink and bell pepper mayonnaises.

Vegetarian Angst

The idea that vegetarians tend to subsidize meat-eaters actually comes as a relief to self-described "dainty" diners such as Valerie Lichman, a New York public-relations executive. When she goes out with her girlfriends, Ms. Lichman says, "we all order salads and side orders of steamed vegetables, and think the restaurant hates us." While Ms. Lichman doesn't plan to change her ordering habits, she says she will feel less guilty from now on since her dinner choices probably generate "a tidy profit."

Still, why don't restaurants simply charge more for high-cost dishes and less for cheaper ones? After all, it seems only fair. Shoppers who buy a Brand X blouse at a department store don't subsidize society dames who buy designer wear, and compact-car owners don't pay more so the dealer can cut deals for luxury-sedan customers.

The answer is partly marketing and partly psychology. Straying outside a certain price range can be risky for a restaurant. A $3 soup on a menu where most appetizers are in the $8 to $12 range will either cause a run on the soup, or scare people away because they think something is wrong with it. Likewise, a dish might not find takers if it is priced too high. When screenwriter Chris Lynch recently ate at the Italian restaurant Drago in Santa Monica, Calif., the waiter announced the daily special was pasta with truffle sauce. "Oooh, I think I'll get that," Ms. Lynch said -- until her dinner companion insisted she ask the price. "It was $58," says Ms. Lynch, who ordered another dish. "Paying that much for an entree when everything else was $15 to $25 seemed outrageous."

A loose rule of thumb in the industry: For restaurants where the average per-person check is $40, keep entrees within a $10 price range; for restaurants where the average check is $20, keep entrees within a $5 price range.

6. What do the above pricing schemes suggest about consumer behavior? Does it follow the utility-maximizing rule? If not, what rules do they follow? Are these rules rational?

Looking Cheap

Oddly enough, the least-expensive item on a menu occasionally is put there to encourage people to order something slightly more expensive, says Mr. Buckley, the New York cooking-school instructor. "There are people who won't order the cheapest thing on the menu" because they don't want to look stingy, he says. So with the next two or three higher-priced items, "you want to make sure they have the greatest profit."

Indeed, there is often a science to restaurant pricing. The savviest restaurateurs have computer programs that allow them to enter the contents of every dish and get an exact price on each ingredient and the overall cost of a single serving. Tennessee's Real Barbecue Real Fast, a three-chain restaurant based in Framingham, Mass., for example, uses a computer to monitor inventory and register the cost of every ingredient, down to the sprinkling of spices on its signature ribs. "If someone with a heavy hand is portioning out seven ounces of beans, we check into it," chef-partner Steve Uliss says. Owning restaurants "is now becoming a lucrative business if they're run in the right way."

Tracking such minutiae is one reason why the notoriously risky business of operating a restaurant has become a bit more stable, industry watchers say. According to Dun & Bradstreet, 100 out of every 10,000 U.S. restaurants failed in 1997 -- the latest year for which figures are available. But Arlene Spiegel, director of the food-and-beverage practice at PricewaterhouseCoopers, says the business climate for restaurants has "improved in the last three years."

Still, many restaurants maintain they are in an extremely tough industry with very tight profit margins. At Quilty's in New York, where attorney Mr. Wolf thought he paid too much for his pork chop, owner Jason Ungar says the entree "may have a bigger markup" than some others because "pork is probably going to sell anyway." Mr. Ungar says the thinking is: "Can we make up with the pork a little on the steak?" He adds: "I'm sorry if anyone walks out feeling they paid too much for an entree. There's no aspect where we're making a killing."

ANSWERS TO ARTICLE ANALYSIS QUESTIONS

Chapter references appear after the answer to each question. The micro split chapter number is given in parentheses.

    1. One possible economic reason why vegetarian dishes have a higher mark up is that vegetarians aren’t willing to change quantity demanded by much when price changes. That is, their demand is inelastic. That means that a restaurant which is able to post prices will find that it can increase revenue by increasing its price on vegetarian meals. [McConnell: 20 (7); Colander: 21 (7)] Return to article.
    2. Restaurant owners must pay for chefs, kitchen prep, kitchen cleanup, bus boys, lights, the building, heat, to name a few. They also must pay themselves. This is most likely what is meant by profit—the salary of the owners. Only the marginal costs are important to the pricing decision. That would include the cost of the raw materials and the time it takes to prepare the food. In the long run, however, price must cover average total cost for the restaurant to stay in business. It is common for these other costs to far exceed the cost of the raw materials. The Colander text, for example, explains how the raw materials needed to produce a box of $3.35 Wheaties costs only $0.35. The remaining costs include shipping, boxes, and advertising. [McConnell: 22 (9); Colander: 5 Appendix and 23 (9)], Return to article.
    3. It is difficult to say with this information what the market structure is. It could be that the restaurant faces a perfectly elastic demand curve at the market price so that all restaurants have the same mark up. Or it could mean that all the restaurants are colluding to charge the same mark up. I’d need some information on market structure to make a more informed determination. Market structure, then, also depends upon how the market is defined. If the market is the very exclusive restaurants like Le Cirque in New York, I’d say that the market is less than perfectly competitive. At over $100 per plate Le Cirque is most likely earning above-normal profit suggesting it is in a less-than-competitive market. Le Cirque keeps a close eye on the prices of its competitors and may implicitly collude with competitors. If the market is all restaurants in New York City, I’d say that it is close to perfectly competitive because there are many restaurants in New York. [McConnell: 23 & 24 (10 & 11); Colander: 28 (14)]Return to the article.
    4. It is perfectly rational to eat out even though the cost is much higher. Individuals follow the rule: Choose that activity that provides the highest marginal utility per dollar. A restaurant provides additional marginal utility over and above the food purchased at the grocery store for a variety of reasons: (1) the food is prepared for you, (2) the ambiance, (3) you may be trying to impress your date, etc). The value added the restaurant contributes is the menu price less wholesale prices. In order that they appear on the table they are: $9.50, $12.56; $17.00; $13.95; $11.87; $13.01. [McConnell: 7 (macro question); Colander: 8 (macro question)]Return to article.
    5. The differing mark ups suggest that there are differing elasticities of demand for different food goods—those foods with the higher mark up have more inelastic demands . The Sunset Grill does not just sell pasta and vegetables because the demand for these goods depends upon the restaurant offering other foods. People demand French fries only after they order a juicy steak. Since the French fries cost so little compare to the steak demand tends to be inelastic. The same goes for other items such as garden salads. People who go to restaurants demand a full selection of meals—not just individual items. [McConnell: 20 (7); Colander: 21 (7)]Return to article.
    6. People’s decisions are contextual. That is, people tend to compare prices within a small range of prices. Once the decision is made to go to a restaurant the likely relevant comparisons are other menu items. That means items must be priced relative to one another. Also people make decisions based upon rules of thumb. One rule of thumb is that price indicates quality. Don’t buy the cheapest item—it might not be as good. Lastly, people are affected by peer pressure. Buying the cheapest food might signal to others at the table that you are a cheapskate. When you’re ordering at a restaurant, you’re not just buying food; you are conveying information about how you make decisions, your buying habits, and how savvy of a diner you are. [McConnell: 21 (8); Colander: 22 (8)] Return to article.

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