Question

The first sushi restaurant opens in town. Initially people are very cautious about eating tiny portions of raw fish, as this is a town where large portions of grilled meat have always been popular. Soon, however, an influential health report warns consumers against grilled meat and suggests that they increase their consumption of fish, especially raw fish. The sushi restaurant becomes very popular and its profit increases. a. What will happen to the short-run profit of the sushi restaurant? What will happen to the number of sushi restaurants in town in the long run? Will the first sushi restaurant be able to sustain its short-run profit over the long run? Explain your answers. b. Local steakhouses suffer from the popularity of sushi and start incurring losses. What will happen to the number of steakhouses in town in the long run? Explain your answer.

Short answer

Question: Analyze the impact of a health report on the profit of the first sushi restaurant in town and the number of sushi restaurants in the long run, as well as the situation of local steakhouses in the long run. Answer: In the short run, the first sushi restaurant's profit will increase due to higher demand for sushi. In the long run, more sushi restaurants will open, leading to increased competition and decreased short-run profits. Local steakhouses may experience lower demand and profits, possibly leading to market exit for some in the long run.

Step-by-step solution

a.1- Short-run profit of the sushi restaurant

As the demand for sushi increases due to the health report, more people will visit the sushi restaurant. This increase in demand will lead to higher prices and more consumption of sushi, resulting in a higher short-run profit for the sushi restaurant.

a.2- Number of sushi restaurants in the long run

As the first sushi restaurant becomes successful, higher profits will attract more entrepreneurs to open sushi restaurants in town. In the long run, the number of sushi restaurants will increase to meet the demand. This is a process known as market entry.

a.3- Sustainability of short-run profit in the long run

In the long run, as more sushi restaurants open in town, competition among them will increase. The increased competition will lead to a decrease in sushi prices, driving short-run profits down. Eventually, the market will reach a long-run equilibrium with normal profit levels, meaning the first sushi restaurant will likely not be able to sustain its initial high short-run profit in the long run.

b- Impact on steakhouses in the long run

As people shift their preferences towards sushi, the demand for grilled meat at local steakhouses will decrease. The lower demand results in lower revenues and profits for steakhouses. In the long run, some steakhouses may incur losses and be forced to shut down their businesses. This reduction in the number of steakhouses is a process known as market exit. This will continue until the remaining steakhouses can earn a normal profit by serving the reduced demand for grilled meat.

Key concepts

Short-run Profit

In the short run, businesses like the first sushi restaurant in our exercise can experience heightened profits. This scenario often arises due to an increase in demand without an immediate increase in supply. For the sushi restaurant, the higher demand was triggered by a health report encouraging the consumption of raw fish over grilled meat. As more people flocked to the sushi restaurant, the initial establishment saw increased sales and, consequently, greater short-run profits.
In such cases, demand outstrips supply, allowing the restaurant to charge higher prices. This pricing power, combined with increased sales volume, boosts profits temporarily. However, it's important to remember that these profits are typically not sustainable over the long haul unless the market remains uncontested by new entrants.

Long-run Equilibrium

Long-run equilibrium in a market refers to a state where supply equals demand, and all firms earn normal profits. When the sushi restaurant started making high short-run profits, this nudged other entrepreneurs to open their own sushi restaurants. This is an example of how markets naturally work towards equilibrium.
As more restaurants entered the market, competition increased. This competition typically leads to price reductions as businesses vie for customers. Over time, as the number of sushi restaurants in town grows, the prices tend to fall.
In long-run equilibrium, no firm makes extraordinary profits. Instead, they earn what's called 'normal profit,' which means enough to cover all costs, including the opportunity cost of being in that business. This process aligns with market equilibrium theory, ensuring that supply meets demand efficiently.

Market Entry and Exit

Market entry and exit are natural dynamics that help stabilise a market over time. In our example, the initial surge in sushi demand led to significant market entry. Many new sushi restaurants opened as entrepreneurs sought to capitalize on the high demand and profits. However, the reverse dynamic can be seen with steakhouses. As the preference shifted towards sushi, steakhouses experienced reduced demand. This lack of demand can lead to losses, prompting some of these businesses to exit the market.
Such market exits happen until the remaining establishments reach a point where they can sustainably operate by serving the existing consumer base. This process balances the market and ensures resources are allocated where they are most needed, reflecting consumer preferences.