Why would lowering quantity supplied cause to quantity demanded to increase?

Question

I am reading an article about price-takers versus price-makers and it says the following:

A Price Maker has the ability to alter the output of its product at any time to suit its needs for profit maximization. For instance, if a firm wants to increase its price, it will reduce the amount of the product output inducing demand. However, a price-maker can regulate supply only when it has a monopoly over the product.

Why would reducing the quantity supplied cause the quantity demanded to increase? Let’s say that quantity demanded is 100 when quantity supplied is 100. But then, quantity supplied drops down to 50. Why would I, as a consumer, suddenly demand more just because the overall quantity decreased? Furthermore, why would I be willing to pay more for something just because there is now less of it? Like, if I’m willing to buy a car for 40,000 dollars when the supply of cars is, let’s say, 1,000, why would I suddenly be willing to buy a car for 60,000 dollars if the supply of cars dropped to 500? Especially if I have to get the car from the same supplier no matter what.

Also, a secondary question, why would a company limit its supply just so it can sell at a higher price? Wouldn’t it make more sense if they kept the price relatively lower so they make more money overall rather than raise the price and make less overall? For instance, you would make more money from selling 100 units at 5 dollars each than 50 units at 9 dollars each. The implication I get from the article is that a company should just make only one product or item so they can sell it for the highest possible price.

Answer 1

Why would reducing the quantity supplied cause the quantity demanded to increase.

It doesn't. The quote is confusingly written, I am not even 100% sure it says that demand will increase since the quote could be read as that the amount of output which inducts demand decreases, not that reduction of output increases demand. In any case if the author of the quote meant to say that this increases demand they were simply wrong.

In the case described by the quote demand would not change, rather firm by varying its production can move up or down along demand curve (see discussion of this mechanism in Frank Microeconomics and Behavior ch 12).

Also, secondary question, why would a company limit its supply just so it can sell at a higher price? Wouldn’t it make more sense if they kept the price relatively lower so they make more money overall rather than raise the price and make less overall?

That depends on the parameters of the economy. If the demand for company product is perfectly elastic then it would make sense to keep the price low.

However, aside from special cases monopoly firm can typically increase its profit by reducing production, although this can be done only up to some point and not arbitrarily. Profit is a non-linear and typically concave function of quantity produced and as a result there will be usually some optimal price and quantity that is not at an extremes.

This can be easily shown mathematically.

Suppose you have monopolist facing demand given by $p=100-q$. Monopolist cost of producing are $10q$. Then monopolist profit is given by:

$$\Pi = p(q)q -10q = (100-q)q-10q.$$

Suppose monopolist only cares about profit maximization then optimal quantity is given by q that solves:

$$\Pi'(q)= 0 $$

$$100-2q-10=0 \implies q^*=45 \implies p=55.$$

Note the monopoly above could charge $p=50$ and then sell $q=50$ and still earn economic profit (at $p=50$ and $q=50$ profit would be 2000), but since the monopolist wants to not just earn profit but maximize profit, and there is no competitive pressure, it won't do so as that would not be profit maximizing (since at $q=45$ and $p=55$ profit is 2025). However, by same token monopolist would not charge $p=60$ because even though price is higher at that point profit is no longer maximized.

Answer 2

lower price means that the consumer is getting a 'better deal' and will be more inclined to purchase. if more people are willing to buy at this lowered price - aka the 'better deal' - then the demand - aka the volume/# of people willing to buy that # of goods for that price - has increased.