Economist's Notebook: Bertrand Price Competition and Pizza

Photo Credit: Hiroko Masuike/The New York Times

One of the great puzzles of living in Portland is how the market sustains such high pizza prices.  When I lived in Ithaca, NY I was used to New York style pie and prices - both great.  Somehow in Portland pizza commands premium prices: a large "very veggie" pizza at Pizzicato is $24!  You have got to be kidding.

It is a puzzle to me because it is such a contestable market and a pretty standard product.  Pizza kitchens are pretty darn cheap compared to regular commercial kitchens: just get an oven and you are off.  And, sure there are quality differences, but making good pizza is pretty easy, doesn't take a lot of work or training.  In economics this market seems to be characterized most closely by the Bertrand model of price competition.

This model assumes some market power (so not perfect competition which would fail to capture the product, location and brand differentiation) and that firms compete on price.  It does assume homogeneous goods, so it is not a perfect description, but pretty close. But the conclusion of the model is that through strategic interaction, competitors will undercut each other on price because consumers are pretty indifferent about the different pizza shops so they'll just go to what is cheaper.  In the end what you get is prices that equal the marginal costs or providing it - exactly what you get from perfect competition.  

So I was heartened to see this article from The New York Times which describes the knock down drag out pizza wars of Manhattan that has lead to 75 cent slices:

It’s best to start at $1.50 a slice.

That is what pizza was selling for about a year ago at a family business that is a combination vegetarian Indian restaurant, candy store and pizza parlor on Avenue of the Americas (also known as Sixth Avenue), between 37th and 38th Streets. It is called Bombay Fast Food/6 Ave. Pizza.

Then a Joey Pepperoni’s Pizza opened near the corner of 39th and Avenue of the Americas, offering pizza for $1, a price that has in recent years been favored by a number of New York pizza establishments.

So Bombay/6 Ave. Pizza shrank its price to $1 too.

All was good until last October, when a third player entered the drama.

A 2 Bros. Pizza, part of an enlarging New York chain of 11 shops that sell slices for a dollar, opened virtually next door to Bombay/6 Ave. Pizza. The only separation is a stairwell that leads up to a barbershop and hair salon.

Price stability at a buck all around persisted until eight days ago, when both 2 Bros. and Bombay/6 Ave. Pizza began selling pizza for the eye-catching price of 75 cents a slice, tax included — three slender quarters.

This is exactly what you would expect to happen in this market from the application of the Bertrand market.  The article goes on to quote a pizza shop owner who claims that there might actually be predatory pricing: pricing below marginal cost to try and force competitors out of the market.

But the $1 slice that appears like it might be about MC is a heck of a lot cheaper than Portland prices and in a city where rents are a lot cheaper than NYC.

So, armchair economists, explain to me the high Pizza prices in Portland.  I have my own pet theories, but I'd like to hear yours first.  And while you are at it, explain to me the $10 pub cheeseburger.  

UPDATE: It appears Greg Mankiw has beat me to the punch on this.