On February 12, 2006, the price for a large bowl of freshly stretched noodles went up some 15% in all the noodle shops at the name-sake home city of Lanzhou. Price hike in the new Chinese market economy is not unusual in itself. But what was unusual were the simultaneity and the uniformity of the price hike for the city’s staple diet. In a business with elbow-to-elbow competition among freely multiplying mom-and-pop shops, such unison actions are contrary to the principles of economics 101.
Homogeneous products (also known as commodities) and free entry of new shops mean that there is no upward pricing power among competitors. Those who attempt to raise price will quickly lose customers and be eliminated from the business. In other words, noodle shops are price takers. A price hike would succeed only if every shop decides to do it in unison. But getting the many small competitors acting together is almost impossible. The temptation for individual shops to undercut the colluded price is too hard to resist and be controlled.
Any unison effort to raise prices must therefore be the result of some coercive conspiracy. Sure enough, some ringleaders were behind a coercive agreement to raise prices on Black Sunday. Briefly, all noodle shops did raise their prices in unison. But just as soon as the price hike was introduced, there were non-price competition to lure customers with freebies from a newly opened shop. One shop had even gone back to its old prices after seeing a downturn in customers.
High cost in labor, wheat flour, and taxes will eventually have to be covered by price hikes. But it will likely be led by stronger competitors who can withstand some temporary loss of customers and whose noodle soups are more valued by well-off customers.
- New York Times. 3/4/2006. “Noodle prices rise, along with Chinese tempers.”