BUS 540 Module 2 Demand and Elasticity Example

Raise the Coffee, Hold the Bagels: Demand and Price Elasticity for a Bakery-Cafe Chain's Menu Pricing

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MBA Program, Aspen University

BUS 540: Managerial Economics

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Month Day, Year

Raise the Coffee, Hold the Bagels: Demand and Price Elasticity for a Bakery-Cafe Chain's Menu Pricing

Buckeye Hearth Bakery Cafe, a composite chain of 22 cafes in central and southern Ohio, sells breads, bagels, pastries, sandwiches, soups, coffee and specialty drinks, and it caters office meetings, with about $13.5 million in annual sales. Over the past year, the cost of flour, butter, eggs and coffee beans rose about 9%, and wages rose as well. The owners plan to raise every menu price by 6%. Their operations director worries that some customers, especially those who buy bread and bagels, will go to grocery stores instead. This paper uses demand theory and elasticity to decide where price increases make sense.

What Drives Demand at a Bakery-Cafe

The quantity of a product customers buy depends on its price, the prices of substitutes and complements, customers' incomes, tastes and the number of competitors nearby (Baye & Prince, 2022). For Buckeye Hearth, substitutes vary by category. Bread and bagels compete with grocery stores and warehouse clubs that sell similar products for less. Coffee and specialty drinks compete with other cafes, but many customers choose by habit and location. Sandwiches compete with fast casual chains. Catering competes with other caterers and restaurants but is ordered by businesses whose decisions turn on reliability and convenience.

Measuring Responsiveness

Own-price elasticity compares how far purchases move with how far price moves, both in percentage terms, and is normally quoted without its minus sign. When it is below 1, demand is inelastic: quantity falls by a smaller percentage than price rises, so revenue increases. When it is above 1, demand is elastic, and a price increase reduces revenue. A cross-price figure tracks how sales of one item react when a different item's price changes; positive values indicate substitutes, negative values complements. A third measure links purchases to customers' earnings, which matters for a chain whose prices sit above grocery store equivalents.

Evidence From Research

Andreyeva et al. (2010) reviewed 160 studies of the price elasticity of demand for food in the United States. Their average estimates ranged from about 0.27 for eggs to 0.81 for food away from home, with soft drinks at 0.79 and juice at 0.76. Most food categories were inelastic, but food eaten away from home was among the most price-sensitive. Ellison and Ellison (2009), studying an online price comparison site, found extremely high price elasticities for products where shoppers could compare prices instantly. Their findings suggest that elasticity depends heavily on how easily customers can compare alternatives, which is relevant for bread and bagels displayed beside grocery store prices in customers' minds.

The Chain's Own Test

Published averages describe broad categories, not one chain's customers. Buckeye Hearth therefore tested a price change. For six weeks, six cafes raised all coffee prices by 8%, while six similar cafes, matched by sales volume and location type, kept prices unchanged. Cups of coffee sold fell 3.4% in the test cafes relative to the comparison cafes. The estimated own-price elasticity for coffee is 3.4 divided by 8, or about 0.43, well within the inelastic range. Pastry sales in the test cafes fell 1.1% relative to comparison cafes, a sign that pastries and coffee are complements, bought together.

Elasticity by Category

Combining the test, the research and sales data, the operations director estimated elasticity for six categories and the effect of a 6% price increase on each category's revenue.

Revenue changes are calculated as the new price times the new quantity relative to the old: for coffee, 1.06 times 0.974, or about 1.033. Bread and bagels stand out as elastic, because customers can buy similar loaves for less at grocery stores and the chain's test of earlier bread promotions showed strong responses to price.

Complements and the Whole Basket

Because coffee and pastries are bought together, raising coffee prices slightly reduces pastry sales, and the reverse may also hold. A uniform 6% increase would therefore reduce pastry quantity through two channels. The analysis suggests keeping pastry increases modest so that coffee customers are not discouraged from adding a pastry.

Competitors and Customer Mix

Elasticity also depends on who the customers are. Morning customers at suburban cafes are commuters buying coffee on the way to work, a habit that changes slowly. Afternoon customers at downtown cafes are often office workers choosing among several nearby options, and their sandwich purchases are more sensitive. Catering clients are businesses for whom the cost of a breakfast tray is small relative to the meeting it serves. Bread and bagel buyers are more likely to be households doing weekly shopping who compare prices with the grocery store they will visit anyway. These differences in customer situations explain why the same 6% increase would have very different effects across categories.

What the Owners Proposed and Why It Falls Short

A uniform 6% increase would raise revenue in five categories but lose about $47,000 a year in bread and bagel revenue at current volumes, and it would risk losing bread customers who also buy other items on their visits. The targeted plan raises more revenue overall while keeping the price that customers watch most closely unchanged.

Recommendations

Buckeye Hearth should raise coffee and specialty drink prices by 7%, catering prices by 8% and sandwich and soup prices by 4%, raise pastry prices by 3%, and hold bread and bagel prices steady while promoting a bread loyalty card. The estimates suggest that this pattern would raise total revenue by roughly 3% while protecting the bread customers most likely to leave.

Limits of the Estimates

The coffee test lasted six weeks; customers may respond more over time as they form new habits. Published elasticities are averages across many settings. Income changes, such as a downturn, would raise price sensitivity. The chain should monitor category sales monthly and repeat tests before further increases.

Conclusion

A uniform price increase treats every product as if customers respond the same way. Elasticity shows they do not. Coffee, specialty drinks and catering can carry higher prices with little loss of volume, while bread and bagels face close substitutes and should be held steady. Demand analysis turned a blanket increase into a targeted pricing plan.

References

Andreyeva, T., Long, M. W., & Brownell, K. D. (2010). The impact of food prices on consumption: A systematic review of research on the price elasticity of demand for food. American Journal of Public Health, 100(2), 216-222. https://doi.org/10.2105/AJPH.2008.151415

Baye, M. R., & Prince, J. T. (2022). Managerial economics and business strategy (10th ed.). McGraw Hill.

Ellison, G., & Ellison, S. F. (2009). Search, obfuscation, and price elasticities on the internet. Econometrica, 77(2), 427-452. https://doi.org/10.3982/ECTA5708