Question

McDonald's Corporation is an American fast food company, founded in 1940 as a
restaurant operated by Richard and Maurice McDonald , in San Bernardino, California ,
United States. They rechristened their business as a hamburger stand, and later
turned the company into a franchise , with the Golden Arches logo being introduced in
1953 at a location in Phoenix, Arizona . Although McDonald's is best known for its
hamburgers, cheeseburgers and french-fries , they feature chicken products,
breakfast items, soft drinks , milkshakes , wraps , and desserts . In response to changing
consumer tastes and a negative backlash because of the unhealthiness of their food,
the company has added to its menu salads , fish , smoothies , and fruit .
In March 2010, McDonald’s Corp. announced a policy to increase summer sales by
selling all soft drinks, no matter the size, for $ 1.00. The policy would run for 150 days
starting after Memorial Day. The $ 1.00 drink prices were a discount from the
suggested price of $ 1.39 for a large soda. Some franchises worried that discounting
drinks, whose sales compensate for discounts on other products, could hurt overall
profits, especially if customers bought other items from the Dollar Menu. McDonald’s
managers expected this promotion would draw customers from other fast-food
chains and from convenience stores such as 7-Eleven. Additional customers would
also help McDonald’s push its new beverage lineup that included smoothies and
frappes. Discounted drinks did cut into McDonald’s coffee sales in previous years as
some customers chose the drinks rather than pricier espresso beverages. Other chain
with new drink offerings, such as Burger King and Taco Bell, could face pressure from
the $ 1.00 drinks at McDonalds.
Questions
a. Given the change in price for a large soda from $ 1.39 to $ 1, how much would
quantity demanded have to increase for McDonald’s revenues to increase?
b. What is the sign of the implied cross-price elasticity with drinks from McDonald’s
competitors?
c. What are the other benefits and costs to McDonald’s of this discount drink policy?
……….

Answer 1

Questions and Answers:

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a. Given the change in price for a large soda from $1.39 to $1, how much would
quantity demanded have to increase for McDonald’s revenues to increase?

The price reduction from $1.39 to $1 is approximately a 28% reduction.

Therefore, quantity demanded has to increase by more than 28% for any visible changes in revenue.

This is because Total Revenue = Price x Quantity

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b. What is the sign of the implied cross-price elasticity with drinks from McDonald’s
competitors?

The drinks from McDonald's competitors are substitutes.

The implied cross-price elasticity sign is positive.

This implies that if other drinks become relatively costlier, the quantity demanded of McDonald's drinks will rise.

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c. What are the other benefits and costs to McDonald’s of this discount drink policy?

• Costs to McDonald's
  • the cheaper drinks could bring down overall profits
  • as customers may buy only cheap items from the menu, the expensive items are left unsold
  • the brand image of unhealthy food doesn't improve due to the discounts
• Benefits for McDonald's
  • customers from competitors will be attracted to McDonald's, and sales will rise
  • these customers could also increase sales of the new beverages offered by McDonald's
  • competitors will have difficulties in matching the low prices and variety offered by McDonald's, thus improving market share