Question

Watch Out for Rising Dry-Cleaning Bills In the past year, the price of dry- cleaning solvent doubled. More than 4,000 dry cleaners across the United States disappeared as budget-conscious consumers cut back. This year the price of hangers used by dry cleaners is expected to double. Source: CNN Money, June 4, 2012 a. Explain the effect of rising solvent prices on the market for dry cleaning. b. Explain the effect of consumers becoming more budget conscious along with the rising price of solvent on the price of dry cleaning. c. If the price of hangers does rise this year, do you expect additional dry cleaners to disappear? Explain why or why not.

Short answer

Higher solvent prices raise dry cleaning costs, reducing demand. Combined with budget-conscious consumers, businesses may see reduced profits. Higher hanger prices might cause more dry cleaners to close.

Step-by-step solution

- Understanding Market Dynamics

When the price of a key input, such as dry-cleaning solvent, doubles, the cost of providing dry-cleaning services increases. To cover these higher costs, dry cleaners may raise their prices. However, if they raise prices too much, they risk losing customers who might seek alternatives or dry-clean less often.

- Rising Solvent Prices Effect

Consumers' responsiveness to price changes (price elasticity of demand) will determine the impact on the market. If demand is elastic, consumers will substantially reduce their dry-cleaning consumption as prices rise, leading potentially to a decrease in the number of dry cleaners.

- Budget-Conscious Consumers and Rising Solvent Prices

With consumers becoming more budget-conscious, their demand for dry-cleaning services decreases. Combined with rising solvent prices, this creates a situation where dry cleaners might struggle to maintain business as higher operating costs and lower consumer demand squeeze their profit margins.

- Impact of Rising Hanger Prices

If hanger prices double, dry cleaners face another cost increase. With consumers already cutting back on dry cleaning and facing higher services prices because of solvent costs, the additional cost of hangers could further reduce profitability for dry cleaners. This may lead to more businesses closing.

- Conclusion

Overall, rising costs of solvents and hangers, paired with more budget-conscious consumers, could indeed lead to more dry cleaners going out of business. The overall effects are fewer businesses and potentially higher prices in the remaining establishments, exacerbating the cycle.

Key concepts

price elasticity

Price elasticity of demand measures how sensitive consumers are to price changes for a good or service. In the context of dry cleaning, if the price of solvents doubles, dry cleaners might need to increase their service prices to cover higher costs.
We can say that demand for dry-cleaning services might be elastic if consumers respond strongly to price increases. This means that a small increase in price could result in a large drop in the quantity of dry cleaning demanded.
With higher prices, consumers are likely to reduce their use of dry-cleaning services or seek cheaper alternatives. The more elastic the demand, the more significant this reduction will be.
If the demand is inelastic, dry cleaners might be able to raise prices without a substantial drop in customer numbers. However, in this case, budget-conscious consumers are already cutting back, suggesting a more elastic demand for dry cleaning.

consumer behavior

When operating costs rise, understanding consumer behavior becomes key. Consumers often respond to price increases by adjusting their purchasing habits. For dry cleaning, this could mean that people might:

• Dry-clean less frequently.
• Opt for less expensive cleaning methods.
• Switch to washable clothing items.

Budget-conscious consumers are especially likely to reduce their spending in response to higher prices. This behavioral change directly impacts the demand for dry-cleaning services. When solvent prices increase significantly, consumers' tendency to reduce dry-cleaning frequency puts additional pressure on dry cleaners.
Overall, a shift in consumer behavior towards cost-saving measures reduces the revenue for dry cleaners and makes it difficult to keep up with increasing costs.

operating costs

Operating costs include all expenses required to run a business. For dry cleaners, this encompasses the cost of solvents, hangers, equipment, labor, and rent. When solvent prices double, the increase in operating costs is notable. Dry cleaners might attempt to pass these costs onto consumers through higher prices.
However, they must balance the price increase with customers' willingness to pay. If consumers are highly price-sensitive, raising prices could backfire, reducing the overall demand for services. The rise in hanger prices further compounds the issue, adding another layer of increased costs for dry cleaners.
Managing these rising operating costs while retaining a customer base is a significant challenge. Increased costs without a corresponding rise in revenue can thin profit margins, pushing some dry cleaners out of business.

profit margins

Profit margins represent the difference between the revenue a business earns and its costs of doing business. For dry cleaners, profit margins are squeezed when operating costs rise faster than prices can be increased.
With both solvents and hangers becoming more expensive, dry cleaners face higher costs. To maintain their margins, they might need to raise service prices. However, as noted with price elasticity and consumer behavior issues, raising prices can lead to decreased customer demand. This scenario requires dry cleaners to navigate carefully between covering costs and retaining customers.
Unfortunately, in a competitive market with budget-conscious consumers, maintaining healthy profit margins is challenging. Many dry cleaners might find their margins too thin to sustain operations, leading to the closure of businesses and fewer service providers in the market.