Restaurant prices and inflation – Econlib

While there are several excellent commentators on the topic of inflation at EconLog, a recent lunch with a close friend got me thinking more deeply about how inflation affects some of my favorite local restaurants. In an inflationary environment, raising prices can be better for customers and the business itself.

During the meal, my friend noticed that the nominal prices of the dishes had increased. As economists, we were not dismayed by this fact for two reasons: A) the food we ate was great as always, and B) we understood that the price increase was largely due to the inflation we have had to endure 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 the prices paid by producers for inputs, increased from 2020 to 2022. Although the latter have declined somewhat, pent-up consumer demand for restaurant meals prevented prices from falling as people returned to their normal lives hungry for the activities they enjoyed before the pandemic. It would be unreasonable to assume that prices at any of our favorite, busy local restaurants would remain constant during this time.

In fact, I was glad to see that this restaurant has raised its prices. The reason is that businesses facing rising input prices and high demand face a difficult choice, especially when they cannot afford to compromise margins in order to survive financially. They have two main options. First, they can raise the prices their customers pay. Wages – the price of labor – tend to rise in an inflationary environment, so customers can stomach the increase.

Second, they can lower the quality. This gives rise to the well-known term “shrinkflation.” Instead of giving you 4 slices of meat on the sandwich, they could give you 2. They could put more water in their tomato sauce or stop serving lemons with your drink. See the Hot dog from Costco to give a typical example. Some methods of reducing quality may be less obvious, such as closing earlier or being more economical (stingy) in using napkins given to customers.

I can remember several cases of the second option in restaurants I used to love. Although the prices were exactly the same as many years before, the quality of their products had deteriorated dramatically. I am disappointed that I no longer visit these restaurants. The reason for this was at least partly the inability or refusal to raise prices to cover the higher costs and the second option was chosen instead.

Although I had to shell out a few dollars more to get it, my last visit for fried chicken and fries was just as good as ever. I was grateful they went with option 1 and I hope this helps keep the restaurant around for many years to come.

Those who say that higher nominal prices for the same quality are all well and good for someone like me, but not for those most in need, should remember that lower quality for the same nominal price is a more expensive mealDon Boudreaux expressed this well in a post in Café Hayek in August 2021, where he predicted the looming inflation before “temporary” vs. “persistent” The debate began.

Second, businesses that keep their prices the same over the long term can run into financial difficulties and reduce quality to the point where the customer base shrinks and the business eventually has to close. Inflation makes it harder to run local businesses. It can be especially hard for owners without formal business training.

Finally, Companies do not cause a general rise in the price level – inflation – is caused by government action, particularly the printing of new money to finance government spending. Politicians are quick to blame others for rising inflation, because admitting that inflation is due to actions they consciously supported and implemented would be tantamount to political suicide and should be avoided by a politician concerned with self-preservation. Firms that do not – or cannot – raise their prices in response are protecting themselves to some extent from the political consequences.

Today's political and digital social environment can discourage companies from raising their prices in response to higher input costs or higher demand. McDonald's and other chains have recently came under fire for prices that have become higher than customers expect from fast-food restaurants. They and others are trying to offer new menu options that provide value and keep prices low. Innovative ways of doing this are commendable and laudable in inflationary and otherwise difficult economic environments. But beware of the Money Illusion; lower quality at the same price leads to a more expensive product. Inflation is to blame, not the entrepreneurs.

Giorgio Castiglia is program manager for the competition project at the Mercatus Center and a doctoral student in economics at George Mason University.