Maths and Tesco

Firstly, some maths. Assuming a firm faces a constant price elasticity of demand (PED) and has constant marginal costs, the price charged is a mark-up over marginal cost that is a function only of the PED faced, in this case, b. In perfect competition, b is infinity, there is no mark-up and price equals cost. In the theoretical case of a perfect monopoly facing perfectly vertical demand, b is zero and the mark-up is infinite. For any other value of b between zero and infinity, the mark-up is in between:

Also note that this result generalises to less simplified forms that don't assume constant PED and marginal cost

So based on this, which companies should consumers hate the most? In this basic set-up, anyone with a high mark-up is facing a low firm-level PED, which means they're exploiting market power, capturing consumer surplus as additional profits and creating monopoly deadweight loss

So why does Tesco seem to be the most hated company in the country? Based on the financial highlights on their Website, for their accounting period ending in 2007, Tesco were making a profit margin of 5.5% at the profit before tax level, which implies a mark-up of 5.8%, which implies they face a firm-level PED of 18, which suggests they face a very high level of competition and charge a price not far above the perfect competition outcome. So on this basis, Tesco should be loved as the consumer's best friend, a large company achieving economies of scale, but without the market power to use this scale to capture consumer surplus, make massive profits (compared to its revenues) and create monopoly deadweight loss.

I'm at a loss to really understand why Tesco is so hated in England. Many rightly claim Tesco are driving small local butcheries, bakeries and grocery stores out of business, but this only happens because consumers prefer the prices and goods at Tesco in the first place, so this is a case of consumers lamenting the loss of shops they weren't really using much anyway. Another common complaint is that Tesco use their scale to negotiate very low wholesale prices, especially when buying from farmers, but as a consumer, surely this is a good thing? I don't know of any other industry in which consumers worry about raw materials and intermediate goods made in the UK getting a fair price ("Fair Trade" is a different issue), so this is almost a more surprising argument than the concern over local little-used over-priced butchers going out of business. I also have no idea why this hatred doesn't seem to extend to Asda, Sainsbury's and Morrisons, businesses very similar to Tescos but less efficient and with less market share. Are these other companies being effectively praised for being less efficient than the market leader?

Any suggestions on why a firm offering cheap, popular, quality products is the most hated in the UK would be much appreciated.

by Indifference Merv | Sunday, August 26, 2007
  , | | Maths and Tesco @bluematterblogtwitter


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