Impact Of Price Drop On Business Demand & Profit †Free Samples

Question: Discuss about the Impact Of Price Drop On Business Demand Profit. Answer: Introduction The base of the microeconomic theory stands upon the law of demand that states price and demand has inverse relation. That is for increase in price of good, the quantity demanded will fall when other factors of demand are constant. But the theory also has exceptions to the law that depicts positive relation between price and goods subject to specific factors and mode of demands. For example, demand for Giffen goods and Veblen goods or luxurious goods can be such example backing the exceptions (Firat et al. 2013). Real world functioning are always different from the suggestions of theoretical models due to various factors that remain unidentified in the theories but do have impactful existence in real economic transactions (Kubler et al. 2013). The paper aims to discuss whether modern day business operations follow the theoretical assumptions and conclusions of law of demand or it deviates from it with assessing the consequent impact on profit. Discussion A business is able to drop its price only if it can make reduction in the operational cost it bears in the production process. The lowered cost stems from various factors like lower input cost like cheap labor and raw material, lower cost of capital in terms of rate of interest and so on (Shephard 2012). Application of technology in the production process can also lead to lower cost of production. These are supply side factors determining the low price in the market for any goods. Now whether this low price would attract the consumer evoking their demand of them depends totally on their willingness to pay which in turn depends on various factors like income, individual taste and preference, social preferences and perceptions, speculation, future expectation, snob effect and so on. Even if the business drops its prices, if the society is inflicted with some preferential attributes like falling demand for cheap goods or whose prices are falling, increasing demand with increase in price operated through snob effect. Speculative market and expectation of any calamity in near future also evoke positive relation between price and demand. It is generally true that fall in price attracts more consumers to buy more of that good as the income effect operates which increases the purchasing power of the consumer (Solomon, Russell-Bennett and Previte 2012). But this may not always happen due to the fact that exceptions to law of demand do exist in the market operations. Possible cases are discussed below. Demand Habits Of Giffen Goods: If the said business produces any goods or services that loses its value and hence demand overtime as the income of the consumer increases, then the drop in its price cannot attract more demand as per the general law of demand. In economic terms such goods whose demand falls with fall in price is called the Giffen goods. The people having lower economic capability or inability consume the goods and as soon as they receive more income they make shift in their consumption basket. These goods are considered to be inferior and have a upward sloping demand curve in the market. Income effects are dominant factor behind such consumer behavioral pattern. Hence fall in price of such goods cannot generate profit which is the ultimate motive behind dropping prices of the goods. Demand Habits Of Veblen Goods If the business consists of production and services, of any conspicuous good that has embedded higher social values in terms of perceptions and monetary assessment, then dropping the price may go against of the prospect of the business since lower price is now indicator of lower gain in terms of values. For example, admirer of diamonds or precious jewels always prefers highly priced goods instead of low priced as it allows them to maintain the social status (Hildenbrand 2014). For this kind of goods also the market demand curve is upward sloping indicating fall in the demand for fall in price. This has detrimental effect on the profit (Hirschey 2016). Speculative Demand Drop in the price by business organization can turn out to be a big failure in increasing demand and profit amidst presence of speculation of the consumers about market movements. In the speculative market if the share prices rise, the demand for it increases due to the expectation generated among buyers that prices will raise further (Harrison 2016). Similarly a fall in prices of share or bond can evoke a general expectation regarding further future decline in the price losing the intrinsic value of the shares. As a result even if prices fall, buyers wont increase demand rather decrease it. Adverse Future Expectation Another exception to the law of demand is expectations made for future economic conditions. For example if the consumers apprehend inflation or hike in price in near future due to shortage of supply of any goods due to any social political or economic factor, then in spite of increasing price today they will demand higher due to the fact that the goods will become costlier in near future (Rios et al. 2013) For example if it is announced that cooking gas will be supplied in less amount from next month, then instead of higher price people will try to buy and stock more of it disrupting the law of demand. So the said business if drops their price that is further expected by the consumers to fall in the future then buying today makes them disadvantageous as future consumption seems economical. So here also the business wont be able to capture higher profit out of drop in the price level. Demand Habits Of Essential Goods These goods have fixed consumption irrespective of the price level. For example, medicines are that essential good that have lesser impact on the consumption due to changes in the price. Even if the price rises, consumers would buy the amount of medicines they need (Armendariz 2015). Contrastingly, if the prices of the medicines fall that is not going to increase its demand overnight as the medicines have no other uses more than the specific needs. Demand Hahbits Normal Goods This kind of goods follows general law of demand. If the price of such goods falls, people consume more of it due to the underlying operation of substitution effect as well as income effect (Varian 2014). A business entity that produces apparels, footwear, and food faces such demand pattern with respect to the price movement. A drop in the price attracts consumers because it seems comparatively cheaper to them now increasing the purchasing power. As a result more demands will be made and this would generate higher profit and revenue growth out of increased transaction. Conclusion From the above discussion it can be concluded that fall in the price might always not increase its demand and profit consequently as there might appear exception to law of demand due to specific behavioral pattern and perception playing behind the demand decision of them. The strategy of dropping price can stem from reduced input cost and cost of production and it can earn higher profit by increasing market demands for the good only if it is normal good. Necessary goods like rice, wheat, food products, and apparel are the mostly consumed normal goods having huge market share and the increase in demand can effectively increase the revenue of the business as well as long term profit. References Armendariz, R., 2015. Comment on giffen behavior and subsistence consumption: the giffen paradox model.Essays on development and international trade, pp.2-8. Firat, A., Kutucuoglu, K.Y., ArikanSaltik, I. and Ungel, O., 2013. Consumption, consumer culture and consumer society.Journal of Community Positive Practices,13(1), pp.182-203. Harrison, J., 2016.Law and Economics in a Nutshell. West Academic. Hildenbrand, W., 2014.Market demand: Theory and empirical evidence. Princeton University Press. Hirschey, M., 2016.Managerial economics. Cengage Learning. Kubler, F., Selden, L. and Wei, X., 2013. Inferior good and Giffen behavior for investing and borrowing.The American Economic Review,103(2), pp.1034-1053. Rios, M.C., McConnell, C.R. and Brue, S.L., 2013.Economics: Principles, problems, and policies. McGraw-Hill. Shephard, R.W., 2012.Cost and production functions(Vol. 194). Springer Science Business Media. Solomon, M., Russell-Bennett, R. and Previte, J., 2012.Consumer behaviour. Pearson Higher Education AU. Varian, H.R., 2014.Intermediate Microeconomics: A Modern Approach: Ninth International Student Edition. WW Norton Company.