A penny for your thoughts
By Scott Sumner
Tyler Cowen links to a recent study of Canadian grocery store pricing (the first three lines are Tyler):
There is the danger that prices will be rounded up more than down. A 19-year-old Canadian, Christina Cheung, has done a study of penny abolition in Canada and here are her findings:
She found 60.8 per cent of grocery store prices ended in 8 or 9.
Cheung put those numbers through a computer simulation program that generated hypothetical purchases.
“I simulated [grocery purchases] depending on what province you’re in, what tax rate you have, and how many items you buy,” she said.
She excluded the volume of credit and debit card transactions, which aren’t affected by penny rounding.
She then made a discovery: a typical grocery store would earn an additional $157 of revenue from rounding each year.
I’m not quite sure I understand what is being studied here. At first I assumed that the study had showed that grocery stores usually rounded up after the penny was abolished. On a second look it appears that she predicted this would happen. If so, I’m not quite sure why.
If raising prices would actually raise revenue for grocery stores, then why not do it even before the penny is eliminated? One answer is that it’s a game theory problem; this action only benefits stores if all firms raise prices from $9.99 to $10.00. Any firm that did not cooperate would steal business from other firms. But in that case, if the penny is removed then a non-cooperative firm could just lower the price to $9.95 and steal business away from other firms. Sure, they’d lose 4 cents by doing that, but I notice that an increasing number of stores already just give me a few pennies for free to avoid the hassle of counting out each coin. If it’s truly a good strategy, then why not price at $XX.95? Wouldn’t the failure to do so cost sales; dare I say “penny wise, pound foolish?”
Maybe I’m missing something, but I don’t see how this increases the revenue of grocery stores. There would have to be more than 4 increases from $9.99 to $10.00 for each cut from $9.99 to $9.95 in order for stores to get more revenue. Add in the fact that the grocery industry is pretty competitive, which means that if profits increased then the entry of new firms would also increase.
I strongly favor getting rid of the penny, and maybe even the nickel. In 1973, the smallest coin was a penny, which was worth the same as a nickel is today. We got along just fine without a smaller coin. In 1913 the smallest coin was a penny, which was worth as much as a quarter is today. Why do we need small change filling up our pockets, and imposing heavy costs on the government?
PS. In the early years of the country there was a half penny, but it was killed off in 1857 when it had roughly the purchasing power of a dime today. Not needed.
PS. I feel like a horrible person criticizing a paper by a 19-year old student that got published in a scholarly economics journal. (Perhaps I am a horrible person.) But I’d like to think that my critique is a way of showing respect. A penny for your thoughts?