The behavior of sellers in perfectly competitive markets when they restrict quantity sold

The Palo Alto has received huge demand for their foods within the market, while another restaurant, providing same kind of services with comparatively higher prices, cannot increase its demand. According to the demand law, increase in price of foods can lead the quantity demanded of those items in an opposite direction (Amir, Erickson and Jin 2017). In this context, other factors, like income, tastes and preferences of consumers along with impact of related commodities are considered as constant. This is because; those factors can also influence the demand for foods significantly.

The popular restaurant has excess demand for their foods compare to the supply. According to the demand and supply concept, excess demand influences the price of a product to increase further (Tian 2016). Hence, this concerned restaurant can also increase prices for their foods to earn higher amount of revenue.

 

Figure 1: Excess demand for the popular restaurant

Source: (created by author)

The figure 1 has represented a negatively sloped demand curve of the restaurant. Moreover, this figure has also depicted an upward rising supply curve of this restaurant. By equating these two curves, the popular restaurant can obtain an equilibrium price level along with its corresponding level of output. In this figure, P_e and Q_e are represented those amounts price and output, respectively. However, according to the given situation, this concerned food seller has charged a lower price to its customers. The figure has denoted this price by P1. Thus, according to the figure, this popular restaurant has Q1Q2 amount of excess demand at this lower price level. In this context, it can be mentioned that, the seller has not increaseed its supply to fulfill this excess demand. From this, it can be stated that the concerned food seller has enough opportunity to increase its price of foods up to P_e level. By increasing the amount of price, this popular restaurant can earn more revenue.

On the other side, restaurant with empty seats may decrease their prices for attracting more customers. Due to higher amount of prices, the demand of this restaurant has decreased and consequently excess supply has occurred (Goldenberg et al. 2017). Hence, it can be beneficial for this specified restaurant to decrease its price level. This can also be described with the help of a diagram.

 

Figure 2: Excess supply for the empty seat restaurant

Source: (created by author)

In figure 2, the demand and supply curves of this restaurant with empty seats have been drawn, while each curve has possessed its normal slope. By equating these two curves, equilibrium amount of price and corresponding level of output of this restaurant can be determined. Those amounts equilibrium amount of price and output are P_e and Q_e, respectively. However, this less popular food seller has charged higher amount of price, that is, P2, compare to its actual market price. Consequently, this empty seat restaurant has Q3 Q4 amount of excess supply at this higher price level. Hence, by attracting more customers, this restaurant can reduce its excess supply. For doing so, this concerned food seller may reduce its prices for foods by P2P_e amount.

The case study of two seafood restaurants in Palo Alto

a)

In a perfectly competitive market, a seller has an upward slopping supply curve, which can be obtained from the upward rising portion of the marginal cost curve (Gerakos and Syverson 2017). From this positive slope of supply curve, it can be said that an increase in price can lead the concerned seller to supply more amount of goods.

 

Figure 3: Short-run supply curve in a competitive market

Source: (created by author)

According to this figure, the short-run supply curve of is seller can be denoted by SJ portion of the total marginal cost curve. S is the minimum level of production below which a seller needs to shut down its business activity. That means this is the minimum level of production from where the seller can bear its fixed costs only. However, beyond this point, the seller cannot bear its total cost and it becomes beneficial for the concerned seller to stop production. Hence, form this, it can be stated that a seller has possessed an upward slopping supply curve, under this competitive market. Here, this concerned person is supplying Q0 amount of output at price level P0. Moreover, the concerned seller has gained P0C amount of profit from this market.

Now, the seller can restrict the amount of product supply in the short-run under perfectly competitive market. This implies that, at initial price level, the concerned person is now supplying fewer amounts of foods. However, by restricting the amount of supply, the seller can bear less amount of production cost (Azevedo and Gottlieb 2017). This implication can be represented with a suitable diagram.

Figure 4: Supply restriction of a seller under short-run

Source: (created by author)

According to above figure, the seller has restricted its supply of production by Q1Q0 unit. However, the concerned person, being a price-taker, can charge P0, as before. In addition to this, the production cost of this seller has also decreased by C0C1 amount. Hence, in this situation, this person can earn higher amount of profit, compare to before. In the above figure, it can be seen that the amount of P0C1 is greater compare to the P0C0.

 b)

According to the assumptions of perfect competition, the number of buyers and sellers is large within the market. Moreover, each seller and buyer has perfect knowledge regarding the activities of other buyers and sellers (Keyhani, Lévesque and Madhok 2015). Each seller is supplying identical products to their customers.  Consequently, a buyer can substitute one item with another, as each goods are close substitute of each other. The market price is determined by equating market supply of industry with market demand of all customers (Kirzner 2017). Hence, a unique price is charged at which every seller can sale their products and every buyer can buy the one. This means, each buyer and seller is price-taker. However, in the given case study, two restaurants have charged different prices for their foods. This is not the characteristic of a perfectly competitive market. Hence, those restaurants are not performing under this market environment.

How restaurants can maintain exclusivity and enhance profits

According to the given situation, restaurants are operated under monopolistically competitive market, where characteristics of both perfect competition and monopoly can be seen. Under this monopolistically competitive market, large numbers of sellers sell products to the large number of buyers (Assenza, Grazzini, Hommes and Massaro 2015). Here, products, which are sold in the market, can be said as close substitute but the not the perfect one and this in turn has helped a seller to behave like a monopolist. Consequently, each seller faces a negatively sloped demand curve and can charge any prices. Based on those different prices, consumers decide their quantity of demand. Moreover, each seller bears an extra cost for advertisement due to product differentiation. This helps them to attract customers (Dorn et al. 2017). The seller can enjoy normal profit, excess profit or can incur loss during their short-run operation. However, in the long-run, those sellers can leave the market if they incur only loses. This means, a firm can freely enter into the market or can leave from the one.

Based on the above discussion, it can be said that, under this perfectly monopolistic market, different firms can set different amount of prices. This phenomenon has also happened in the given extract. Here, two different restaurants have charged two different levels of prices. Moreover, due to this phenomenon, two restaurants have also experienced different level of demand for their products. On the other side, under a perfectly competitive market, those restaurants need to charge same amount of prices (Gerakos and Syverson 2017). This is because; each seller and buyer acts as a price-taker under this competitive market.

 

Figure 4: Monopolistic competitive market

Source: (created by author)

In figure 4, an equilibrium condition under this concerned market structure, is represented. According to this diagram, the equilibrium amount of output is Q_m while the corresponding level of price is P_m. Here, the seller is enjoying normal profit.

Based on the characteristics of this monopolistic competitive market, it can be stated that all restaurants also follow the same market structure, where each of them sell similar products but these can be slightly different based on quantities and qualities (Frick, Gergaud and Matic 2017). Hence, they can charge different prices for their products and advertise their products to attract more customers.  

Under monopoly market, a seller either can increase the amount of revenue by charging higher prices or can sell higher amount of output by charging lower prices. According to the concept of monopoly, a single firm enjoys the entire market power and this in turn helps the concerned organization to charge any price for its output (Dawes 2017). Hence, the firm faces a negatively sloped average revenue curve or the demand curve. This implies a negative relation between prices, charged of the firm, with its quantity demanded.

Potential gains and losses to profit for a monopolistic seller that restricts quantity supplied

Figure 5: Monopoly Market

Source: (created by author)

The above figure has depicted an equilibrium condition of monopoly market, where Pe denotes the equilibrium amount of price and Qe represents the corresponding level of output. If the seller charges higher amount of price by Pe P1 unit, then the amount of quantity demanded can be decreased in the market by Q1 Qe unit.

However, under the assumption of “value of exclusivity”, a seller has decided to restrict its amount of output, keeping the price at lower level. According to this phenomenon, the seller is now selling lower amount of output at a fixed price (Peres and Van den Bulte 2014). As the monopolist does not possess any supply curve, the impact of supply restriction influences the demand curve of that concerned person. The concept of excludability along with lower price helps a seller to increase its demand for product my significant amount. Consequently, the demand curve and marginal revenue curve of the concerned person have shifted to the right. This can be explained with the help of below diagram.

 

Figure 6: Impact of value of restriction on a Monopoly seller

Source: (created by author)

According to figure 6, the initial level of demand curve for this seller is represented by D1 curve. Hence, the corresponding marginal revenue (MR) curve of this person is represented by MR1. By equating the marginal cost (MC) curve with MR1, the seller can get equilibrium amount of output and its corresponding level of price. The above diagram has represented those amounts output and price by M1 and P. After implementing supply restriction, the new demand curve of this seller has become D2 and the corresponding marginal revenue curve has become MR2. Hence, at Price P, the quantity demanded for the output has increased by M1M2 amount. Consequently, the concerned person can earn OPBM2 amount of revenue compare to the previous level. This has helped the seller to earn more profit as cost has remained at E2M2 unit. This amount is low compare to the previous amount of cost, that is, E1 M1 unit.  

Hence, the seller has not incurred any loss in this context. By charging lower prices, the concerned person has led the demand to increase further. On the other side, by charging higher prices, seller can influence the demand adversely and this in turn can force the profit of that person to decrease by significant amount.

The concept of price discrimination in restaurants and its implications

4:

a)

Through price discrimination, a monopolist can charge different prices for same product. This phenomenon is also applicable for a restaurant (Ding and Wright 2017). After restricting the quantity supplied, a seller can adopt some illegal activities to offer the same product at higher prices. This concept can be described in the following diagram.

 

Figure 7: Price discrimination under monopoly at fixed price level

Source: (created by author)

The above diagram has represented a condition of price discrimination for a monopoly seller. According to this figure, the initial demand curve and marginal cost curve are D0 and MR0, respectively. The seller can receive equilibrium amount of price and output by equating demand curve or average revenue curve with marginal cost curve. The initial amount of price is P0, at which the seller is selling Q0 amount of output. To produce Q0 amount of output, the seller needs to bear some costs, which are represented by average cost (AC) curve. However, after applying sale restriction, the concerned person can charge higher price, that is, P1 through applying illegal activities for providing same amount of output (Heywood, Wang and Ye 2018). The cost structure of this concerned person has remained stable position. Thus, the seller can earn higher amount of profit. This can also be described with the help of figure 8. The initial amount of profit is P0C while, after price increment, this amount can be represented by P1C unit. According to the figure, the difference between C and P1 is greater compare to the difference between C and P0.

In this context, the seller can charge P0 price for some customers and P1 price for others, who want to pay higher prices. Here, legal price is P0. As the product has huge demand in market, producers can increase this demand more by restricting supply. However, the concerned person cannot practice this illegal activity, if the market demand has been decreased significantly for this higher amount prices (Schulte and Pibernik 2017). This is because, under monopoly market, a firm or seller cannot influence both price and its quantity demanded. Consumers influence the demand for a product, based on its prices.

b)

According to the nature of monopoly power, price discrimination can be divided into two parts. Those are anti-competitive and pro-competitive. Under anti-competitive price discrimination, the monopolist can enjoy the entire market and no other firms can enter into it. The chief reason behind this anti-competition is the pricing strategy of the monopolist (Agostini, Willington, Lazcano and Saavedra 2017). The person set the price level in such a way that this discourages other firms to enter. This happens when the seller charges lower price. As other firms cannot charge this lower level of prices, the monopolist does not experience any competition.

Market conditions necessary for perfectly competitive markets

Pro-competition, on the other side, describes the opposite concept. In this competition, other firms can enter into the market and consequently, the market has turned into a competitive one (Jora et al. 2017). In this situation, other firms can charge same amount of prices like the monopolist. Hence, the impact of price discrimination has become ineffective.

In the given case study, price discrimination can be seen in the form of anti-competitive. According to this concept, a large seller or restaurant can charge lower price on its product to restrict other small sellers from expanding their business (Agostini, Willington, Lazcano and Saavedra 2017). This in turn can help this large restaurant to reduce its competition level. Moreover, this restaurant can practice price discrimination by large extend.  

According to the law of demand, price and quantity demanded has a negative relationship. This implies that, an increase in price of a particular commodity can decrease its quantity demanded, significantly. Moreover, the opposite situation can also be occurred (Spinner, Casale, Brosig and Kounev 2015). In this situation, a decrease in price can influence the quantity demanded for this commodity to increase further. However, demand curve can be influenced by other factors as well. For instance, changing income or tastes and preferences of a consumer can influence the demand for this product when price level remains unchanged. Hence, by considering those factors as constant, the negative relation between price and quantity demanded can be discussed.

Based on the above discussion, it can be stated that a negatively sloped demand curve can be seen for a particular product. This is also true for the houses, gold. Those items have possessed elastic demand curve with negative slope (Hilber* 2017). In this context, the concept of price elasticity can be mentioned. According to this concept, a small change in price can influence the demand for those products by large extend. When housing prices or price of gold has decreased by small amount, the demand for those products has increased significantly (Diederich and Goeschl 2017). The following diagram can show this.

Figure 8: Elastic demand curve for houses and gold

Source: (created by author)

The above figure has represented an elastic demand curve for houses and gold. Based on this figure, it can be described that the demand for those products has increased by Q0Q1 unit when their price has decreased by P0P1 unit. Moreover, the amount of Q0Q1 is greater compare to that of P0P1.

Monopolistic competition and its impact on pricing in restaurants

On the other side, company shares have faced a positively sloped demand curve. This means, the demand law is not applicable here. Consumers demand more amounts of company shares when their prices have started to increase (Bayoumi and Eichengreen 2017). The opposite situation has occurred when prices of those products have started to decline. This can also be represented with help of above diagram.

Figure 9: Upward rising demand curve for company shares

Source: (created by author)

Figure 9 has represented an upward slopping demand curve for company shares. According this figure, the demand for company shares has increased by Q0Q1 unit while the price of this product has also increased by Q0Q1 unit.

Hence, from the above discussion, it can be stated that the houses and gold has followed the law of demand. However, this law is not applicable for company shares.

The demand curve today for both houses and gold can shift to the right, if consumers expect that the demand for those products can increase in future (Burt et al. 2017). This is because; an increase in demand can lead the prices of those products to increase in future. Hence, the demand for those products may increase today at same price level.

Figure 10: shift in demand for houses and gold

Source: (created by author)

Figure 10 has represented that the initial demand curve for houses has remained at Q0 while price is remained at P0. However, after future prediction of consumers, this demand curve has shifted to the right. Hence, at same price level, consumer can demand Q1 amount of output.

Moreover, for company shares, the same situations can occur. In this context, consumers can shift along the demand curve and this in turn can lead the buyers to move along the demand curve (Ammenberg 2018). Figure 10 has represented this situation.

Increase in demand for houses, gold and company shares can lead the price of those products to increase in future. Prices of those items can decrease in future (Venizelou et al. 2018). However, based on predictions, consumers have started to demand those items by more amounts. This excess demand further can influence the price to increase in today and consequently consumers can assume this increasing trend in future.

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