The Economics of Ice Cream

With summer quickly on its way out, I realized this is my last chance to make a post I've been meaning to write since I started the blog.

Sometime in May, a few of my friends and I went down to the nearby Dairy Queen for a frozen treat. The day was sweltering but, in typical Michigan fashion, it had been in the low 60s and raining the day before. When we arrived at the DQ, there was a line of people spilling out the door. I thought of how the previous day there must have been nearly no customers.

As I sweated in line, I asked myself why the price hadn't adjusted between the two days. Every student in their second or third week of econ 101 encounters a classic supply and demand problem where  a heat wave increases the demand for ice cream, causing the price and quantity of ice cream to increase. In ideal Econoland, long lines don't exist because firms will jack up prices when demand exceeds supply and lower prices when the opposite is true.

However, as my wait extended into its fifteenth minute, I saw that this was clearly not ideal Econoland. Of course, econ 101 also teaches that prices do not instantly adjust for a wide variety of reasons. Customers feel betrayed when a firm changes its prices, especially when they're jacking them up right when the customer wants the item most. Prices also don't adjust because firms don't want to go through the trouble of changing they're menus and calculating new prices every month, let alone every day. In fact, many economists identify price stickiness as a main cause of recessions because firms can't respond to sudden changes in demand without laying off workers.

This econ 101 story, though a sufficient explanation of why DQ isn't changing its prices every day, still left me unsatisfied. I still wondered why there wasn't more variation in the price of ice cream from, say, winter to summer. The change in demand must be substantial enough to justify charging a bit more. I decided to do a search on google scholar for articles on the price changes of ice cream (or lack thereof) between seasons.

After a bit of sleuthing, I stumbled on this gem of an article in the Journal of Industrial Economics. It was ungated when I accessed it from K, but for whatever reason I can only get to the abstract now. The author hit onto the same thing I did but instead for a variety of goods. Turkey and stuffing at thanksgiving? Doesn't get more expensive. Chicken wings at the super bowl? Nope. Same thing for ice cream. In fact, the authors find that prices typically decrease at demand peaks! That DQ blizzard is probably cheaper on a hot July day than it is in the middle of December.

The traditional story for this phenomenon is that supply ramps up in anticipation of big demand. Farmers know that the super bowl creates a lot of demand for wings, so they raise a few more chickens. Supply and demand tells us that this increase in supply will lower prices, canceling out the price increase from the demand shift. This is one alternative to the econ 101 story and it seems to make sense. However, the authors reject this explanation, noting that retailers don't get much better deals from farmers.

The explanation that the author settles on is that it all boils down to competition and market concentration. One of the defining traits of Econoland is perfect competition. Any good you can imagine is being produced by tons of different producers, and consumers can easily choose between any of their many options. In reality, the production of most goods is dominated by a few firms, and real world competition is closer to an oligopoly than it is to perfect competition. When a market is dominated by a few players, they have the power set prices above what competition would normally push it down to. The result is that the normal price predicted by supply and demand no longer applies, and instead the firm or firms in control will be able to set a price that maximizes their profits. Part of the reason for this oligopolistic tendency is that customers aren't fully informed of all their options. They go with the brand they know best on the supermarket shelves, or just walk to the nearest ice cream store.

When demand for a product increases, the concentration of customers increases, making it easier for businesses to advertise. Because everyone is looking to buy chicken wings for the Super Bowl, every chicken wing retailer will want to run advertisements on TV leading up to the big game. The result is that consumers become better informed. A customer may become aware of a brand they had never considered before. The result is that these markets move a little bit away from oligopolistic competition and a little closer to perfect competition. As markets become more competitive, firms have less power to set prices, resulting in a better deal for the consumer. So we find ourselves with those lower prices even when demand is peaking, all thanks to our friend competition.

Sounds good in theory, but the story is a little complicated. The author backed up his assertion by running a statistical analysis on data from hundreds of different goods whose demand varies widely by the time of year. What the author finds is that markets where several brands are competing saw larger price drops than markets dominated by a single firm. This finding fits the theory, because markets with a few firms will see that spike in competition brought on by better informed consumers unlike markets where there's only one firm.

What I love about this paper is that it takes theory and applies real world data analysis. Is this the entire story? Probably not, but the author has made some intriguing observations that suggest it is part of the story. We started in ideal Econoland and observed something that cannot happen there. Rather than throwing up our hands and declaring economics useless, we asked why Dairy Queen doesn't fit into Econoland. There are many answers; increases in supply, price stickiness, behavioral factors, and as this paper explained, imperfect competition. By analyzing the unchanging price of the DQ blizzard through the lens of economics, we can better recognize the deeper factors at work.