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REFUSAL TO SELL

by Valentino Piana (2011)

 
     
 
 

Contents


 
 
1. Significance
 
 
2. The neoclassical explanation for the refusal to sell
 
  3. Is refusal-to-sell common?  
  4. Realistic reasons for refusal to sell  
  5. The response of the perspective buyer  
  6. Conclusions  
 
 
 

Significance

Sellers can refuse to sell goods requested by perspective buyers. The neoclassical theory postulates that this happens in competitive markets in the short run because the price would not cover the marginal cost of producing a further unit.

This short paper explores reasons for refusing to sell and whether they match the neoclassical analysis.

The neoclassical explanation for the refusal to sell

In the neoclassical theory of firms, the short-term marginal costs (the black line) are rising, after having fallen and having reached a minimum.

Figure 1 - The neoclassical assumptions on costs

The producer compares the marginal costs with the sale price (the blue line):

Figure 2 - The neoclassical argument for the seller to choose whether to sell or not

The producers sells all units (e.g. the point C) that have a marginal cost below the price (the blue line), because when the blue line is higher than the black line, the sale of that unit has been profitable. In the opposite geometrical case, the sale is unprofitable. In equilibrium the price is equal to the marginal cost: the last unit to be sold (A) has generated no profit.

If there is an additional consumer (B), the seller responds "no" and refuses to sell.

In B, the marginal costs are higher than the price, so it is unprofitable to accept to sell. In other words, the producer is constrained by costs to refuse to sell. Marginal costs are the reason.

To make further examples of neoclassical standpoint, look at this spreadsheet, paper, and software.

Is refusal-to-sell common?

Now let's go into common sense general situations you experiment with the producers you know. Is it common that you are refused a good you when you are willing to pay the current price? If the equilibrium has already been achieved, you should systematically be refused, because you represent the "further unit" whose marginal cost is higher than price.

Please reflect on your experience. It is very rare to hear that! The seller is usually extremely happy that you want to buy and to pay the current price. In any day you enter a shop, when you take the good from the shelf and are ready to pay, the retailer never stop you and say: "Gosh, this unit has a higher cost than the current price". Indeed, they fix the price so that they have a profit on costs. If not, they usually would raise the price.

The neoclassicals assume that - in normal conditions they call "perfect competition" - the producer is a price-taker: he does not fix the price but accepts what is the market norm. Well, even when this might occur (for instance in an open square with many farmers selling the same vegetables at the same price), they usually do not refuse to sell.

It would be more appropriate to assume that sellers are quantity-contrained by consumers - they fix the price higher than costs and then try to sell as much as they can, a) with inventories being a buffer for demand fluctuations or b) accept orders and producing exactly the quantity requested. It's the buyer that says "stop", not the seller.

Realistic reasons for refusal to sell

When you go to a company shop, which could be good reasons for the people to prevent you from buying a good unit you want and are willing to pay?

The first reason is simply that the unit is not on the shelves: there has been a break in inventories, so they say: "Sorry, we sold all the available units, please come back later or purchase a different version".

Basically, they expected a certain level of sales, there was a surprise (more sales than expected) and because of their replenishment routines, the time to produce and to recieve components and supply (possibly linked to supply chain problems) you were in the company shop in a moment in which there was no such a good available. It's a matter of time, not of costs. Some time later, the good will be again there (and nobody will refuse to sell it to you). Maybe the provision will be definitely interrupted. The good has exited the spectrum of goods that are on the shelves. This is a strategic decision (not a quantity decision: the quantity they produce and sell is zero).

Please note that, in contrast to the neoclassical assumption that producers directly sell to all consumers, in reality there are distribution channels, with a variety of point of sales (some of which might be dependent and other independent from producers).

In another common situation, at restaurants the tables could be all reserved or occupied, so you are asked to wait or leave. The productive capacity of the restaurant has been saturated and they can accept no new orders if the latter have to be delivered immediately. But if you accept to wait, sometimes they will simply postpone servicing and not simply refuse. Thus, again, it is more a matter of time than of cost. In the short run, the fixed asset they use for production has a limited capacity and without it they cannot produce further unit.

Moreover, the refusal to sell at a restaurant has also a dimension for quality: by showing a long queue, restaurants raise the perception of being very trendy (conversely, empty restaurants tend to produce a miserable impression and potential clients are discouraged). In other cases, the refusal to sell would produce a negative image, forcing customer to change provider, possibly for ever.

Perhaps one might argue that the amound of space at the restaurant has been dictated by cost considerations. This is possibly true, but the latter would be strategic considerations on total costs, on total demand, and on the overall sustainabilty of a larger restaurant (which possibly "destroys" the quality of a nice tiny restaurant...), not on marginal costs. And investment in new capacity exceeds the short run of the previous neoclassical analysis.

In brief, the second case for refusal to sell is saturation of production capacity.

A third case of refusal to sell is when just one specific asset is on sale (e.g. a house) and the owner is looking for a sequence of potential buyers, while judging that the current proposal is not satisfactory. This case is far from the neoclassical assumption of replicability of production (volume) taken in the aforementioned case.

A fourth case is more radical than the third: one specific asset is not on sale but somebody else than its owner strongly wants it. A refusal to sell is what would be expected in most such cases; however, the perspective buyer could a. propose such a high price that convince the owner to sell; b. exert a pressure on institutions and circumstances so that the owner is forced or persuaded to sell; c. open a negotiation with the owner leading to a different contract enabling some of the advantage of ownership (e.g. a lease).

A fifth case is discrimination, out of race, gender, nationality,... of the perspective buyer. This should not happen, and in certain countries is punished by the law. Conversely, the law could dictate other exclusions from sales (e.g. alcohol to too young people). All this makes the refusal to sell a legal question and not only an economic one.

A sixth case would attribute the refusal to sell to mismatches between the proposed sale and "standard" market conventions. For instance because of opening hours in a shop you might not purchase during night time. Another common situation is when there is a minimum lot of purchased quantity and the perspective buyer would like to buy less than that. Refusal to sell in these cases tend to segment the market, e.g. with 24h shops or across stages in the distribution supply chain, with the distinction between wholesalers and detailers. By refusing to sell to final consumers, a firm protects the intermediaries. In general terms, these mismatches, if frequent enough, might generate business opportunities to firms offering non standard conditions.

The seventh case is related to the creditworthyness of the buyer who doesn't pay cash but asks for a postponed payment. The seller would refuse to sell if he doesn't believe in the buyer's promise. In business-to-business transactions, postponed payments are extremely common, which in turn means that across the supply chain there is a strong need for mutual trust and that relationships are not necessarily so anonymous and competitive as the neoclassical theory assumes. If I need to wait for a payment, I shall look carefully at my business partner and if my past experience is good I shall repeat the transaction, possibly even giving him more comfortable payment deadlines. The issue of creditworthyness is even more important in banking transactions, where collateral guarantees are usually asked in front of a loan.

An eight case is when the supplier has one or a few competing version of the goods and does not want to offer further variants to avoid "cannibalization".

A ninth case is specific to the insurance market. Getting a client which has a higher-than-average probability of having a negative shocks to be compensated by the insurer negatively affect the latter profitability, if the premium is equal for all customers. Moreover, ex-post the insurer "regrets" to have acquired a customer who actually filed a claim well above the premiums is paying. Proxies variables will tend to give the insurer a hint to refuse to sell to "bad clients". You can explore this issue in this simple excel file, commented here.

The response of the perspective buyer

In the neoclassical case with perfect competition, the perspective buyer simply goes to another anonymous seller to purchase the same good for the same price. If many buyers are switching and total demand grows, the market price will increase. So a large refusal to sell is conducive to higher prices.

In utility terms, the buyer is not annoyed at the refusal - it is automatically and smoothly absorbed. There is nothing personal in it.

In realistic cases, being refused a purchase usually leads to disappointment, regret if not even anger (especially if motivated by discrimination). The consumer will possibly raise a "memory flag" for "avoiding coming back" or even "discourage others to come here".

As we mentioned before, it is possible that at the same time the perceived quality of the good increases. Everything depends on the motivation for refusal as perceived and framed by the consumer.

For instance, in respose to the sixth reason of refusal, some consumers might explore different sources for the good and new firms would innovate the market conventional routines.

If the seventh case is repeated economy-wide (with banks stopping to provide credit at the current interest rate), because of a general fall in the prices of assets used as guarantees for credits (e.g. real estate assets), then an increase of interest rates (the price rise pushed by neoclassics as the correct answer to large-scale refusals) would make things worse, because it would further depress the assets prices. Investments would continue to fall, in a positive feedback loop.

Conclusions

Normally a consumer having the purchasing power and willing to buy a good on sale under standard market delivery conditions will be able to get the good. Refusal to sell is not usually justified by marginal cost arguments but other, broader, reasons.

Realistic examples in your own life are better grasped by a theory of consumers, costs, and market interactions different from the standard neoclassical perfect competition with rising marginal costs.

In this site, we are contributing to such an alternative theory of production and consumption: we consider consumers as bounded rational, firms as facing simpler cost structures, and market interaction hinging on quality, innovation, reputation, routines, and advertising.

 

 
 
 
 
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