Restaurant Prices and Inflation
Although there are several great commentators on inflation at EconLog, a recent lunch outing with a close friend provoked me to think more deeply about how inflation has been affecting some of my favorite local restaurants. It can be better for customers and the business itself to raise their prices in an inflationary environment.
During the meal, my friend noted that the nominal prices of the meals had gone up. Being economists, we were undismayed by this fact, for two reasons: A) the food we were eating was great, as usual, and B) we understood that the price increase was due in large part to the inflation we have endured over the past few years.
From June 2020 to June 2024, the annual CPI inflation rate was over 5%. The Producer Price Index, an index of prices paid by producers for inputs, soared from 2020 and 2022. Though the latter has come down a bit, pent-up consumer demand for restaurant meals kept prices from retreating as people returned to their normal lives hungry for the activities they enjoyed before the pandemic. It would be unreasonable to assume that the prices of one of our favorite busy local eateries would remain constant over this time.
In fact, I was glad to see that this restaurant had raised its prices. The reason is because businesses facing rising input prices and high demand face a tough choice, especially if they can’t afford a blow to their margins for financial survival. They have two primary options. First, they can increase the prices that their customers pay. Wages – the price for labor – tend to rise in an inflationary environment allowing to customers absorb the increase.
Second, they can cut quality. This invokes the familiar term “shrinkflation.” Instead of giving you 4 slices of meat on the sandwich, they could give you 2. They could add more water to their tomato sauce or stop serving lemons with your beverage. See the Costco hot dog for a case in point. Some methods of reducing quality can be less obvious, like closing earlier or economizing (being stingier with) napkins handed out to customers.
I can recall several instances of the latter option in restaurants I used to love. Although prices were exactly the same as many years before, the quality of their product had changed dramatically for the worse. I’ve disappointedly stopped patronizing those restaurants. The culprit, at least partly, was an inability or refusal to raise prices to cover higher costs and instead using option 2.
Although I had to fork over a few more dollars to get it, my recent trip for roast chicken and fries was just as good as always. I was thankful they chose option 1, and I hope it will help the restaurant stick around for years to come.
Those who would say that higher nominal prices that preserve quality are all well and good for someone like me, but not for those most in need, should note that reduced quality for the same nominal price is a more expensive meal. Don Boudreaux made this point well in a post at Café Hayek in August 2021, where he predicted impending inflation even before “transitory” v. “persistent” debate got underway.
Second, businesses that keep their prices rigid over the long haul can struggle financially and reduce quality to the point where the customer base shrinks in a vicious cycle until the business has to close. Inflation makes local businesses tougher to manage. It could be particularly tough for owners without formal business training.
Finally, businesses don’t cause a general rise in the level of prices – inflation – government policies do, particularly by printing new money to finance government spending. Politicians are quick to blame others for rising inflation because admitting that inflation stems from policies they deliberately supported and carried out is tantamount to political suicide and to be avoided for a self-preserving politician. Businesses that don’t – or can’t – raise prices in response shield them to some degree from the political consequences.
Today’s political and digital social environments can discourage businesses from raising prices in response to higher input costs or higher demand. McDonald’s and other chains recently came under fire for prices that have grown to higher than those customers expect fast-food establishments. They and others are attempting to offer new menu choices that deliver value and keep prices lower. Innovative ways of doing this are laudable and praiseworthy in inflationary and otherwise tough economic environments. However, beware the Money Illusion; lower quality for the same price leaves you with a more expensive product. The culprit is inflation, not business operators.
Giorgio Castiglia is the Program Manager for the Project on Competition at the Mercatus Center, and a PhD student in economics at George Mason University.
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