Why do some businesses choose scarcity as their business model instead of raising the price to meet the demand?

Question

Here are some examples of what I'm talking about:

• Mass events such as Burning Man, the Olympics, and the World Cup sell out tickets very quickly which forces fans to resort to scalping or using bots if they want to secure a spot
• Theme parks like Disneyland are constantly overcrowded and require patrons to stand in lines for hours, rather than increasing ticket prices to reduce wait times to a minimum
• Concerts of popular artists sell out very quickly which creates a massive scalping market
• Limited editions of clothing suffer from automated bots buying up and reselling almost all of their stock in a matter of seconds
• Popular restaurants sometimes require making a reservation several days in advance or don't take reservations and have everyone wait in line for a long time
• Daycares in Canada and the US frequently have waiting lists of several years which forces parents to sign up for one as soon as they conceive

I'm sure there are more examples of such practices that I'm not aware of. All of them could have addressed the difficulty of obtaining the product through some form of dynamic pricing - as demand goes up you increase the price, as demand goes down you decrease it. Various forms of auctions could also be used to determine the price, if required. This is how the world of airlines operates these days - planes are almost never sold out, but you might find that a ticket costs 10x the original price if you buy one right before departure.

1. What's the name for such business policies in economic theory?
2. Why would a business choose to follow such practices?
3. Can this strategy actually result in higher profits over the long term or are businesses losing money by not using dynamic pricing?

Answer 1

Your question is somewhat ill-posed as stated, because none of your examples are good instances of businesses creating artificial scarcity. Each of them are businesses that face real capacity constraints, whether it be building space and fire-code restrictions or an attempt to manage a sort of tragedy-of-the-commons demeaning of the service.

But you are right in wondering why these businesses don't run their prices up until demand meets capacity. It's basically down to a choice by the business whether to ration through pricing, or ration through queueing.

Queueing is viewed, rightly or wrongly, as a more "fair" means of rationing, since (in the case of non-essential goods) everyone has the same endowment of hours in the day. To the extent that this is true, it's a means to distribute the good or service equitably in a cross-class sense.

It is also a more robust business model in terms of revenue stability, as it leaves much of the "clearing house" work in the respective markets to consumers themselves. One alternative would be to continually monitor the market and adjust prices to keep patronage at or near existing capacity, which is a tricky balancing act that entails potentially high information and menu costs.

Another, obviously, would be to expand the enterprise - but economies of scale must be present. Even then there are associated costs and risks - expansion can serve to dilute a brand, and very few restaurant franchises receive Michelin stars. The market for event space is extremely fraught politically, and the subject of a lot of recent academic interest.

Scalping is an example of arbitrage that takes advantage of the inherent inefficiency of queueing. One can argue that tickets sold in advance of an event must be priced below their value, with the difference being a combination of a risk premium the venue-owner pays to be assured of a full house well in advance and a risk discount that event-goers demand because of the non-zero possibility of their attendance being disrupted at the last minute. Flesh-and-blood scalpers make money off of the rapid market shifts that arise due to the resolving of this uncertainty for both parties, and it could be argued that this leads to a more efficient market.

Of course, software breaks this model entirely, and so I wouldn't make that argument today. But it's certainly true that whatever value scalpers have captured historically was money that even large monopolies like Ticketmaster were not especially inclined to capture for themselves, suggesting that the costs of doing so exceeded the expected benefits.

Answer 2

I think it's more about customer's perception. If they were to raise their prices, they might be perceived as blood-thirsty artists/restaurants/etc. who take advantage of their customers. Instead, by keeping the prices low and having queues outside, it becomes a kind of advertising.

Answer 3

A good answer to my question is contained in Alexander Tabarrok (2008). The hot-toy problem:

A firm wants to build capacity to serve the expected flow demand rather than the unexpected peak demand. Thus, short supply is not difficult to explain. What is difficult to explain is why manufacturers do not exploit the ex post high demand by raising the price of the hot toy,thereby eliminating the shortage

The answer to the problem is later postulated as:

The loss in profit is smaller the larger the shortage because a large shortage is a sign, ceteris paribus, of an elastic demand curve. When the demand curve is elastic a small increase in price is enough to decrease the quantity demanded.

Additionally Tabarrok postulates that for the specific example of toys it could be related to return policies, though this wouldn't apply to things like concert or Disneyland tickets:

Retailers often extensively advertise their return policies such as “If you are not satisfied, bring it back for a full refund.” If the hot toy increases in price whenever there is a seasonal shortage, however, retailers open themselves upto be gamed by consumers. Consumers who purchase at the high price will be motivated to return the product only to buy it again at the lower post-shortage price.

This subject also comes up in Becker, Gary S. (1991) “A Note on Restaurant Pricing and Other Examples of Social Influences on Price.”:

Price increases will be discouraged if consumers believe that they are unfair (see Kahneman, Knetsch, and Thaler 1986). This may sometimes help explain why prices do not rise to take advantage of temporary shortfalls in supply, but it is not plausible when rationing is more permanent. A series of gradual price increases could eliminate the gap in figure 1 without causing serious complaints about unfair pricing.

In this note I provide a different explanation, which assumes that a consumer's demand for some goods depends on the demands by other consumers. The motivation for this approach is the recognition that restaurant eating, watching a game or play, attending a concert, or talking about books are all social activities in which people consume a product or service together and partly in public

Suppose that the pleasure from a good is greater when many people want to consume it, perhaps because a person does not wish to be out of step with what is popular or because confidence in the quality of the food, writing, or performance is greater when a restau- rant, book, or theater is more popular. This attitude is consistent with Groucho Marx's principle that he would not join any club that would accept him

And concludes with the following anecdote:

This may explain why customers who have trouble getting into the popular Palo Alto restaurant mentioned at the beginning of this note do not switch to the nearby unpopular one. When I suggest doing this to my wife, she usually answers that she prefers the amenities at the popular restaurant. But the main difference in "amenities" is that one restaurant is crowded and has queues, while the other one is partially empty and provides immediate seating!

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So to answer my specific questions:

Mass events such as Burning Man, the Olympics, and the World Cup sell out tickets very quickly which forces fans to resort to scalping or using bots if they want to secure a spot

If going to Burning Man became a matter of shelling out $5k for a ticket, it would quickly stop being "cool" and the appeal would go away.

Theme parks like Disneyland are constantly overcrowded and require patrons to stand in lines for hours, rather than increasing ticket prices to reduce wait times to a minimum

Queues in Disneyland are a feature, not a bug. If tickets started costing $500/person, the park would start looking half empty in photos and it wouldn't look "cool" in photos anymore, even though the actual rides experience would be far better. I've also been told by parents that waiting in queues is a huge chunk of the experience for kids.

I'm assuming Disneyland could introduce VIP tickets of some sort that would let one skip all the queues (as done by Six Flags) but this is probably not done to avoid the backlash.

Concerts of popular artists sell out very quickly which creates a massive scalping market

People want to go see these artists precisely because the tickets sell out very quickly, its just part of the experience. Sharing the fact that you snagged a front row seat on a Paul McCartney concert could be just as valuable as actually going there.

Limited editions of clothing suffer from automated bots buying up and reselling almost all of their stock in a matter of seconds

The bots are a "feature", not an actual problem. People complain about them but at the end of the day they still want to buy these items, ensuring that limited editions always sell out and help advertise non-limited items from their store.

Popular restaurants sometimes require making a reservation several days in advance or don't take reservations and have everyone wait in line for a long time

Discussed in detail by Gary Becker in his paper linked above.

Daycares in Canada and the US frequently have waiting lists of several years which forces parents to sign up for one as soon as they conceive

The waiting list symbolizes a high quality of care and ensures a constant supply of customers. Not having one would cause suspicion on behalf of the parents and potential gaps in the number of clients as kids quickly grow up.

Answer 4

Well, this is a hot topic where I live. Basically most of Central and Northern Europe is suffering from an overheated economy in certain sectors. So, if you want to get a house built or some construction repaired, or have some maintenance done on a gas boiler, you are looking at waiting a long time to get someone in, and you are looking at low quality work in general. I won't mention the equivalent problems in health services because that's more a state-vs-corporate pay struggle.

The problem as I see it is that right now personal TIME is way more important than SAVINGS. People simply prefer to earn less and have more quality life, because their sense of SECURITY in potential earnings precludes the need for SAVINGS. In short, people are lazy and prefer to earn enough and work less, rather than work more and earn in excess.