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Economic of doughnuts 08 May 2014 21:17 Looking through the window of a local cake shop last weekend, I saw that doughnuts were 65 pence each. Later in Tesco's, a pack of five doughnuts cost 60 pence. So how can Tesco sell doughnuts for less than 20% the price in a cake shop? Firstly, price is determined by the cost of supply. Not just the cost of making doughnuts (let's assume they are the same for both stores) but also the overheads - premises, labour, heat and light, etc. Tesco has higher overheads than the cake shop, but it can spread them over more items or customers. The overhead cost per doughnut is much lower. Secondly, price is determined by the price of other goods. Most of the cakes at the cake shop were priced between 50 pence and £1. The price of doughnuts was therefore proportionate to the other cakes. If the cake shop sold doughnuts for 12 pence, none of the other cakes would sell. Everyone would buy doughnuts. Tesco sells lots of things for lots of prices, so this factor is not so important. Thirdly - and most importantly - is price elasticity of demand. This is just a complicated way of saying "how much price increases affect demand". Price elasticity at the cake shop is relatively low. People going into a cake shop have already decided that they want to buy a cake, so the cakes can be priced at a higher level. Conversely, people going to Tesco aren't going in to buy doughnuts. They have gone to buy their weekly groceries. Price elasticity is high. Doughnuts are a last-minute purchase and so need to be priced at a "no consequence" price. Five doughnuts for 60 pence? I'll throw them in the trolley. Five doughnuts for £3.25? Er no don't think I'll bother.
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