04
Oct
09

Happy hour economics

During happy hour, demand increases as people who get off work want to go drink. But price falls.

On a classical economic model, an increased in demand leads to an increase in prices. What explains the discounts and deals that bars offer during happy hour?

This excellent paper, suggests that in normal circumstances, bars have monopoly power based on convenience. Some bars are closer to people than others and so can charge a higher price than the market price because of the costs of customers to go elsewhere. This author hypothesizes though that a demand increase (during happy hour times) results in an increased sensitivity to price. People are going to buy more alcohol and so the relative price becomes more important and thus people are more willing to travel to take advantage of lower prices. Because people are willing to travel more, the monopoly power that was supported by travel costs is partially dissolved. An imperfect market becomes temporarily more perfect, and prices fall as a result.

This analysis is very interesting to me,  but I think it fails to explain the happy hour phenomenon. The main reason is that demand is not really increased during happy hour. More people are going out, but each person is not going to buy any more alcohol than usual. Thus, demand is increased, but I don’t think people are any more willing to travel based on the increased amount of alcohol they plan on consuming.

What I think is really going on is that there are network externalities in play at happy hour, so that the demand elasticity increases as price falls. In other words, a small decrease in price brings a few more people to the bar (people who wouldn’t have had a drink after work if the cost was just a little bit higher, which is the normal demand curve behavior), but this small increase in people at the bar has a further effect of drawing still more people to the bar to take advantage of the social atmosphere. If the price is lowered by even more, more people come as a result of the price effect, but then even more people come as a result of the “people” effect. Thus, during happy hour, I think that the lower parts of the demand curve become more price elastic. The monopolist facing this increase elasticity can make more money by lowering prices and having more people come in. Under normal hours of operation, giving a happy hour discount would not incentivize so many people to come in, because only the first group (the group that comes in response to the price effect only) would come in, but the people who come for the sociality would not.

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