The Diner

Media Type: TV Clips Topic: Game Theory, Pricing, Elasticity, The Firm

I Love Lucy

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This episode finds Ricky Ricardo disillusioned with show business.  After some conversation, Ricky and Fred Mertz decide to go into business together and start a diner. Fred and Ethel Mertz have the experience to run the diner and Ricky plans to use his name and star power to help get the word out about the restaurant, which they name A Little Bit of Cuba.  If you have seen any of the I Love Lucy series, you already know that the business venture is destined to fail. Sure enough, the Mertz’s get tired of doing all of the hard work—cooking and serving the customers—while Ricky and Lucy Ricardo meet and greet the guests. Things quickly deteriorate and the two couples decide to part ways. The only problem is that they are both part owners, and neither can afford to buy out the other. So they decide to split the diner in half right down the middle!  The result is absurd and hilarious. On one side, guests go to A Little Bit of Cuba. On the other side, the Mertz’s set up Big Hunk of America. Since both restaurants use the same facilities and sell the same food, the only way they can differentiate themselves is by lowering the price that they charge. This leads to a hamburger price war to attract customers.

How do the falling prices described here affect the ability of the firms in the market to make a profit?

The exchange is a useful way of visualizing how perfectly competitive markets work. Competition forces the price down but the process of entry and exit takes time and it is messy. The Ricardos and Mertzs can’t make a living selling one cent hamburgers – one cent is below their marginal cost – so one of the couples will end up exiting. At that point the remaining couple would be able to charge more. If they end up making a profit, that profit will encourage entrepreneurs to enter the business. As the supply of hamburgers expands, the price that can be charged is driven back down. Since we live in a dynamic world, prices are always moving toward the long-run equilibrium so we rarely see the kind of straightforward analysis you observe in a textbook. 
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