Sunday, September 03, 2006

Demand curves always slope down!!

A few weeks back Ali and I were at the Indian store buying stuff and we saw notices that said "Please limit your lentils purchase to one packet". The lentils cost more than usual, and I was wondering why when we noticed the notices. Although, I needed lentils I put off my purchase for later and decided to shop around for cheaper prices. I could wait a couple of weeks or even go without lentils for a while and have kidney beans instead. The economist in Ali was curious about the notices and we asked the owner about them. There had been a shipment delay and therefore a reduction in supply. Obviously prices went up and the owner also placed quantity restrictions. The price increase made sense, and it was more than enough to deter me from purchasing lentils, but why the quantity restriction?

The buyers at the store are a good mix of students, middle and high income families. About half the student population does not have aid and the other half has low after tax incomes (yours truly included). My guess is that the first two groups atleast would respond reasonably well to price changes, so the case for the notices is weak. If the store owner knows that demand curves slope downward, and I am pretty sure he does, why would he put up those notices? Are they just additional deterrants? Any ideas?

2 comments:

Jason Br. said...

Remember Williams's story about the grocery store manager? This is it exactly.

Compare the reaction of a customer went to the store and there were no lentils with the reaction of a customer who went and was limited to one packet. If the first sort of customer is far more likely to become upset and never return to the store, it could be worth it in the long run.

Brian Hollar said...

I'd say he's not just trying to affect behavior (prices), but also attitude (the sign). It serves several purposes:

1) It gets some people to aks about the restriction (actually, it sounds like more of a request than a restriction), giving the owner a chance to explain what's going on.

2) It appeals to moral sensibilities to limit consumption for those customers are less price-sensitive.

3) It signals that this is a temporary situation, helping aleviate people getting upset about the increased price.

4) It also actively signals that lentil prices have gone up. Flagging this increase rather than trying to hide it and/or letting customers get surprised when they discover the price increase may help build trust and confidence in the shop owner.

My guess is that it is probably some combination of these. You and the store owner know demand curves slope downward, but most customers dont' consciously think in those terms when looking at high lentil prices.

It may also be a case of the shop owner having imperfect information about demand curves and price elasticities of lentils. As such, he's trying a mixed-strategy (high prices and direct requests) to try to limit customer purchases until a new shipment comes in.