Starbucks Economics

I just got back from cashing in my Starbucks card for the free 10th cup. I'm still high from the caffeine fix and promised myself I will never try the grande size again. It's obvious why Starbucks chooses to give you a card that tells you the 10th is free rather than give you a 10% discount for each cup, that's because they want to lure you to buy more cups than you'd buy without the incentive. Easy enough, but just the kind of thing that economists want to use to demonstrate the usefulness of their analytical tools. So let me join my colleagues. Who knows I might be able to use this for a future lecture.



We always start by assuming there are only two goods in the world (we can't draw more than 3-dimensional diagrams). Assume the x-axis maps Starbucks consumption, y-axis represents all other goods. The downward sloping black line (slope=ratio of starbucks price/AOG price), it's our budget constraint (b.c.) and bounds all consumption possibilities in x-y space. The red lines represents the adjustment to the b.c. with the free 10th cup. The blue line is the b.c. if Starbucks chooses instead to cut the price.

The consumer at the original b.c. can be consuming either of bundles A, B, C. Assume there is a consumer whose utility (the green curve) is maximized subject to the b.c. at point E, with the free 10th cup he has an incentive to buy 9 cups (S*) and attain higher utility at point D with the free 10th. If the coffee was discounted instead, he might substitute AOG for the cheaper Starbucks because he's got the extra money to spend between the two goods. The free 10th cup has no additional incentive effect for people who consume greater than or equal to 9 cups but they do benefit. Did I tell the barista this? No. I told her I wanted whip cream with my mocha :)