A few businesses have the power to raise prices without sacrificing much in quantity sold. Others have no price-setting power at all. And many in-betweens might have the administrative ability and legal right to raise prices, but doing so frequently may be a bad business decision.
It isn't always clear which businesses are in what situations. That is why it's best to avoid making sweeping statements about whether additional costs to employers from the Affordable Care Act will be passed along to consumers.
All this is prompted by a blog post by Matthew Yglesias, who writes the popular Moneybox blog for Slate, a Web-based magazine. On March 11, Yglesias ridiculed the franchise owner of eight of the popular "Five Guys" chain burger-and-fries restaurants, who said: "Any added costs are going to have to be passed on."
Yglesias argued that if the businessman had any power to raise prices, he would do so regardless of what happened with the new health law. In the end, Yglesias states that the franchisee acknowledges that he, and any of his investors, would have to eat the loss.
Well, yes and no. Although as a columnist, Yglesias usually is pretty good on the underlying economics, he blew it in this case.
The Affordable Care Act does contain mandates that will raise the cost of labor for many employers. While competitive pressure may currently prevent this business owner from raising prices, eventually, since his competitors also will be subject to the ACA, everyone will be raising prices. The profitability of operating restaurants will be about the same as before, although there will be some adjustments at the margins.
To understand this, start at the extremes. In a pure monopoly that has a single producer of an item, the business can set prices at will. But it still is subject to demand, the quantities of the product that customers are willing to buy at each of a series of prices.
When an anthrax epidemic breaks out, the manufacturer of a miracle antibiotic can set the price very high and still sell out. But if the product is robotic back scratchers or polyester kazoos, raise the price very much and sales might drop to zero.
The flip side is farmers who produce corn, wheat or milk. They cannot raise prices at will. In such a situation of "perfect competition," they are price takers. On any given day, they can choose to sell their product at the going market price or not, but they don't set their selling price. They can take or leave what they are offered.
Most real-world businesses, including franchised burger joints, fall in between these extremes. Their situation is more complicated, both for their managers and for the microeconomics students who have to analyze business behavior.
The willingness to produce and sell a product at different prices, what economists call "supply," depends on the cost of producing the product. Specifically, it depends on the additional cost of producing one more unit, or the marginal cost. If fertilizer or feed prices go up, the marginal cost of producing another bushel of soybeans or pound of pork increases.
"Supply" for a whole sector like soybean or pork or milk production consists of adding up the supply, or willingness to sell, of hundreds of thousands of individual producers. As each individual farmer's costs rise, he or she is slightly less willing to produce. Sum this up across all the farmers, and supply has "shifted." For any given demand from buyers, the market price will be higher, and the quantity produced and sold at least somewhat lower.
This retraction in supply by farmers comes in two ways. With higher input costs, some farmers choose to produce marginally less. Other farmers may just go out of business, particularly if the input cost increase is large and the lag in the market price adjustment is long.
Chain restaurants are not in perfect competition. But the hospitality sector is extremely competitive, since there are myriad restaurants competing for consumers' dining-out budget. Economists call this "monopolistic competition."
Often the only difference is that producers have an identifiable brand. Burgers from Five Guys are different from those of other national chains or beloved local haunts - or the experience of eating them in varying ambiences differs - at least if you believe the advertising.
So no, acting alone, an individual restaurant cannot raise prices significantly without seeing sales drop, perhaps precipitously. But when costs go up for everyone, most businesses in the sector do raise prices. That is true when beef goes up, as it as over the past year, and it will be true when mandated health care raises labor costs.
Such sector-wide price increases are not immediate, smooth, uniform or painless. But they do occur all the time. As long as competitors all increase by roughly the same proportion, market shares and longer-term profitability don't change much. Customers eventually bear most of the cost of the pricier beef or the health insurance.
This isn't true for all sectors. Restaurant meals are "nontradeable." There is no way to import a "dining experience" from China. But apples come from Chile, broccoli from Mexico, and manufactured goods from China and elsewhere. The situation for producers of such "tradeable"" goods is very different.
Moreover, restaurants for which the added health care costs are largely compared with total costs will be affected more than those for which the added costs are minor. That depends on many factors, including how labor intensive the restaurant is, whether it occupies inexpensive suburban land or pricey downtown real estate.
Economist Edward Lotterman teaches and writes in St. Paul, Minn. Write him at email@example.com.