Living Economics

If you are offered 125% more value for just 61% more money, you probably would jump at the offer. Such value offers are quite common in fast-food restaurants in the form of value meals. In fact, that is exactly the offer by trading up from McDonald’s quarter pounder with cheese to the medium extra value meal consisting of a quarter pounder with cheese plus a medium French fries and a medium Coke. The value referred to here is the additional number of calories. Specifically, you pay $1.41 more to get 660 extra calories. But there is another embedded value in the value meal. Namely, you get the same calories from the medium extra value meal for $1.29 less than what you have to pay to buy the items separately. It is this value of bundling that often clinches the deal.

How can McDonald offer such an irresistible deal and still make money? By selling a medium extra value meal instead of just a quarter pounder with cheese, McDonald increases the check per order by $1.41. But the extra cash income has to be large enough to cover the cost of the bundled items in order to make sense. And it does. First, the profit margin on fries and soft drink are high. Second, selling more side orders serves to spread the large overhead cost over more items. Third, it does not cost more labor to process a bigger-check order than a small-check order.

We can look at value meals as a form of price discrimination with lower price for the extra calories. This price discrimination makes sense because of declining average total cost due to increasing returns, making the marginal cost lower than the average total cost (see also Mickey Mouse Economics).

The same economic considerations apply to super-sizing. If the customer can be talked into upgrading to a larger-sized meal, or to a larger-sized soft drink or fries, the check would go even higher.

What is good for McDonald’s bottom line, however, may not be good for America’s waistline. Since 1991, U.S. obesity rates in adults have risen 60%. In the last decade, the percentage of obese children has doubled to almost 27%. But fast-food chains are not entirely to blame. Two persons can always share a value meal and save big at the same time. They don’t have to eat everything on the plate. And McDonald will sell an even cheaper Happy Meal with lower total calories to adults.