On the one hand, small shops are said to represent the "collective memory" as we have more small shops (e.g. a fish-ball or wonton noodles restaurant and old-style bread bakery) in the past. When we were children, we mostly shopped at these small enterprises while nowadays large scale chain shops (e.g. McDonald's or KFC) are more popular.
On the other hand, small shops are often considered to be more humanized with closer personal relationship between the shop owners and the clients. Chain stores cannot offer these good things.
Hence, a social sentiment has been built up, blaming market forces for its driving out these old good things associated with small shops. Such a viewpoint is shared by many people who are concerned with traditional culture.
Regardless of its being right or wrong, such a viewpoint involves economics as it is targeted at market forces. Therefore, if we want to answer questions in relation to small shops, we should not ignore the economics involved in this issue.
Some people may think that the economics viewpoint is already well known: market force is good for the economy; if it drives out small shops, we have no other choices but to accept this.
Some people may think that the economics viewpoint is already well known: market force is good for the economy; if it drives out small shops, we have no other choices but to accept this.
Perhaps this is a popular perception of what economists would say on these issues involving conflicts between market force and tradition or heritage. However, this simple viewpoint cannot cover all economics viewpoints towards markets. I really want to introduce the alternative (but still 100% economics) viewpoint to the readers of this blog, widening their perspectives. My difficulty is that the economics theory involved may go beyond high-school level. I have to try my best to avoid using theory beyond that level. I hope my attempt below can achieve the goal.
Economists are not experts in recognizing social values. However, they are not, as some people believe, someone who recognize only market values (or money values) but ignore any social values.
Economists are not experts in recognizing social values. However, they are not, as some people believe, someone who recognize only market values (or money values) but ignore any social values.
In economics, the value of small shops that cannot be attained by chain stores will be recognized (e.g. memorial and personal-relation values). Meanwhile, the value of chain stores that cannot be attained by small shops will also be recognized (e.g. fast and standardized services). Economics recognize the differentiation between small shops and chain stores, etc. If both small shops and chain stores can be kept, some extra value can be attained. If only either one (small shops or chain stores) is available, the society losses something. These values, due to product differentiation, are recognized in economics via the concept of consumer surplus.
To put it simply, consider two types of products: products and/or services in small shop and chain store. The two products are substitutes but not perfect substitute because of the differentiated features mentioned above. If both types of products are available (people can sometimes visit small shops but sometimes visit chain stores), consumers' benefit should be represented by the total consumer surplus measured from the two types of demand curves of the two goods. If only one type of product is available (e.g. small shop is driven out from market), only the consumer surplus from one type is measured.
To put it simply, consider two types of products: products and/or services in small shop and chain store. The two products are substitutes but not perfect substitute because of the differentiated features mentioned above. If both types of products are available (people can sometimes visit small shops but sometimes visit chain stores), consumers' benefit should be represented by the total consumer surplus measured from the two types of demand curves of the two goods. If only one type of product is available (e.g. small shop is driven out from market), only the consumer surplus from one type is measured.
Chain stores sell standardized products, and minimize personal aspects in their products. Therefore, chain-store products are closer substitutes among themselves (Chain Store A may not be very different from Chain Store B). Small shops, however, are less close substitutes for each other (Noodle Shop A is likely much different from Noodle Shop B) as their products are not standardized. Of course, small shops are even less substitutable by chain stores.
When goods have many close substitutes, their demand curves are flatter (in the extreme case the demand curves for perfect substitutes are horizontal) because people will not hesitate to buy the substitutes whenever prices of a good is raised. In contrast, if goods have no close substitutes, their demand curves are steeper (in the extreme case the demand curves for irreplaceable goods are vertical) because people do not have much other options even though prices are raised. Other things being equal (i.e. at the same price and same quantity), steeper demand curves generate more consumer surplus than flatter demand curves.
Now, when products are differentiated (more or less irreplaceable), each producer faces a downward-sloping demand curve (not a horizontal demand line as under perfect competition), the consumer enjoys the consumer surplus by paying a price lower than their maximum willingness to pay.
Now, when products are differentiated (more or less irreplaceable), each producer faces a downward-sloping demand curve (not a horizontal demand line as under perfect competition), the consumer enjoys the consumer surplus by paying a price lower than their maximum willingness to pay.
Then, how many differentiated products will survive in markets? Are there appropriate number of differentiated products available in the markets? To assess this problem, we have to understand the incentives for firms to enter (or stay in) the markets providing these products. We also want to know if the incentives for firms' entrance decision is in line with social benefit.
In a market with free entry, new producers (small shops or chain stores) will join the market provided that doing so is profitable. Equilibrium is attained when it is no longer profitable to join. When each of these new entrants considers whether to join or not, they consider only the prospective profit but not the consumer surplus, which is earned only by the consumers, not the producers. From the society's point of view, however, consumer surplus matters to the society's benefit and should not be ignored. As new entrants ignore something that should be counted for social benefit, too few entrants may join the market. This bias is called surplus-ignoring effect.
On the other hand, when each new entrant considers whether it should join the market, it also ignores its impacts on other existing producers: as each new firm sells a substitute of the existing producers, the latter's business will be more or less lost to the new entrants. By ignoring this negative impact on others, or the negative externality that is generated by these new firms, too many entrants may be resulted. This bias is called business-stealing effect.
In above, we say there is a bias of firm's entrance decision. This means that firms decide to enter the market by considering the private benefit of entry. But if the social benefit of entry is higher than the private benefit of entry, the incentive for firms to enter is too low (if you bring about $100 benefit to the society but you earn only $60, the society wants you to do more but you won't). If the social cost of entry is higher than the private cost of entry, the incentive for firms to enter is too high (if you bring about a $50 cost to the society but you bear only $30 of the cost, the society wants to you to do less but you won't).
In above, we say there is a bias of firm's entrance decision. This means that firms decide to enter the market by considering the private benefit of entry. But if the social benefit of entry is higher than the private benefit of entry, the incentive for firms to enter is too low (if you bring about $100 benefit to the society but you earn only $60, the society wants you to do more but you won't). If the social cost of entry is higher than the private cost of entry, the incentive for firms to enter is too high (if you bring about a $50 cost to the society but you bear only $30 of the cost, the society wants to you to do less but you won't).
Back to the impact of firm entry, we've discovered two opposing forces: surplus-ignoring effect supports too few entrants while business-stealing effect supports too many entrants. On net, whether the free market supports too few or too many firms depends on the balance of the two effects and cannot be told a priori.
You may wonder: consumer surplus always exists and firms always compete for (and so steal) business from each other. It appears that the above effects always exist. Then, we always don't know a priori if free entry is too much or too little. But isn't economists always supporting free entry in free market?
Answer: they do support free entry but not always; they support only when there is perfect competition. Under perfect competition, each firm faces a horizontal demand. There is no consumer surplus associated with it. Yes, the market demand curve is still downward-sloping. But now we are concerned with the demand facing each new firm (we are discussing whether entry is profitable). Hence, it is the demand facing each firm that is relevant. Meanwhile, under perfect competition, the market is so large and each firm is so small. Each firm does not need to worry about their clients are stolen by other firms as they have plenty (in a big market).
Thus, the framework above works for imperfect market, not for perfect competition.
This framework has been gradually established in the literature of imperfect (monopolistic, in particular) competition (in a 1976 paper by Micheal Spence, the Nobel prize winner, and also a 1986 paper by Greg Mankiw and Mike Whinston). It is generally not known to high-school economics students (who are familiar normally with only perfect competition). I have tried my best to make my introduction simple enough but, as mentioned, it is difficult to do so (so my explanation is lengthy). I hope readers forgive me for not being able to make things easier. The framework, complicated it may be, offers a useful perspective for us to assess if small shops are excessively driven out from market.
So, let us come back to the small shops vs chain stores conflict.
As mention earlier, a small shop is generally not a close substitute to other small shops and chain stores. As such, its demand curve should be steep. The surplus-ignoring effect may also be relatively strong.
Furthermore, introducing one more small shop will not steal too much business from other firms as they are less substitutable for each other. The business-stealing effect may thus be smaller.
Hence, it is likely that the surplus-ignoring effect dominates business-stealing effect, which means there are too few small shops in a free market (and so too many chain stores). This conclusion coincides with the current social sentiment but our reasons are completely economic-theory-based.
Yes, economics may offer more than one perspective for people to think on the issue. In the present case, I think the perspective just introduced is more relevant than the simple free-market perspective (market force drives out small shops but this is good for the economy), which is valid only in a perfectly competitive market.
Yes, economics may offer more than one perspective for people to think on the issue. In the present case, I think the perspective just introduced is more relevant than the simple free-market perspective (market force drives out small shops but this is good for the economy), which is valid only in a perfectly competitive market.
In the real world, retail shops are competing with each other imperfectly. We should use the appropriate model to analyze the issue at hand, instead of using one model (perfect competition) to analyze everything.
Unfortunately, the monopolistic competition framework, involved in the present context, is much more complicated and is not very easy for understanding. This is normally not known to common people, and social advocates in particular. Therefore, these people, knowing no other economics viewpoint, may think that economists will always believe only in free market (let the small shops extinct). But this is certainly not the only conclusion economists will support.
