In the classical, or Newtonian model of capitalism, whenever a merchant raises his prices, his competition will do everything they can to keep their's stable to cut into his business. This is an undeniable fact of life, and we see examples of it every day, it is the mechanism by which the market regulates prices. Normally, this works to the benefit of the consumer, but it is an infuriating inconvenience to the producer.

But the income of a commercial entity is not determined by the price of the commodity it sells (all else being equal). It is determined by the product of the unit price and the number of units sold. It is possible to raise the price of an item and increase income if the decrease in unit sales is more than compensated for by the increased price. In fact, marketers will calculate the price/unit sales ratio to maximize profits, its taught in every business school: analysis of the demand curve and finding the inflecion point where units sold x unit price is maximized. It may even be worthwhile to increase prices and reduce sales and still boost profits because it allows savings in other areas (closing inefficient stores and factories, for example).

This tactic may provide an opportunity for a competitor to expand into your market share, but often this will not happen because the initial costs for them to enter that market segment may not make it profitable for them to do so. It may be more profitable for them to cede some market share to their competitor and invest somewhere else.

Alternatively, a rise in prices may be so profitable (even at reduced unit sales) that a group of vendors may not want to hold prices down when their competitor initiates a price hike. In fact, the competitors in an industry may just be waiting for one of their number to raise prices. Then, they all simply raise their prices too, taking advantage of the newer, more profitable regime. This is usually interpreted as everyone working to keep their prices down until they can no longer and they are dragged into raising them by sheer necessity. It gives the impression that conditions in the industry have forced everyone to raise prices, no matter how bad they wanted not to. Rubbish. What they're waiting for is to see if the initial price rise is indeed profitable at the new sales level. If the first firm gets away with it, they jump on the band wagon. It goes without saying that once this pattern becomes established the risks of raising prices is minimized, so prices are raised across the board. It is easier for this to happen when demand is high relative to supply, but that doesn't mean a higher demand/supply ratio MAKES it happen.

Of course, the classical laws of Adam Smith still hold, and it is possible to miscalculate this and find your profits plummet as your competition undersells you by some miniscule amount. But if this were the only mechanism regulating supply and demand, we wouldn't have marketing executives and universities offering advanced degrees in the field, would we? Or companies offering huge compensation for those who are gifted at it.

For the individual entrepreneur, these calculations may simply not be worthwhile, his share of the market is miniscule and not statistically representative. He may also be doing well enough, thank you, and not want to risk losing his customers by raising prices. Or his competition may be too close on his tail. But for large corporations run by professional marketers--highly-payed employees, not owners--you are NEVER doing "well enough". No matter how profitable you were last quarter the board expects growth.

Yes, Adam Smith's invisible hand is always at work, but there are a lot of clever men out there earning very good salaries by thinking up ways to cut it off at the elbow.