Smith points out that the fast food industry is a good place to watch this theory in action, as these kind of price wars often play out in markets that are oligopolies, where there are just a few big firms all vying to be top dog. For example, if the firm lowers price 5% and quantity sold rises by 10%, then demand is elastic and total revenue will rise.” “A firm can increase its total revenue by lowering price if demand for the product is elastic – sensitive to price. It’s an economic principle called elasticity of demand. Whether or not this latest round of price cuts will succeed may depend on a lot of factors – including the changing face of the fast food industry. Some Burger King franchise owners sued the company in 2009, because a corporate promotion required franchisees to sell a double cheeseburger for $1 that cost a $1.10 to make. Slashing prices to draw in customers can backfire though if cutbacks exceed food and production costs and cannibalise profits. “Part of the strategy is to attract consumers in to the store and then entice them to buy more than just the burger – fries, drinks, desserts.” “McDonald’s will make money selling burgers for a buck if it can make the burger for less than $1 and sell lots and lots of burgers,” says Smith who says that sales of add-on items are also crucial. The key to this strategy? Hoping that customers buy loads of the discounted items. That’s according to Patricia Smith, a professor at the University of Michigan who specialises in the economics of fast food. Eventually, competitors begin out-discounting each other in a race to the bottom of prices.
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