The idea that a price increase will lead to a rise in profits is a blatant economic superstition. While this may hold true in some cases, it is not rare that you see this concept making businesses fall through the floor. People often make the mistake of assuming that increasing their products’ prices will boost their sales, and they only realise their mistake a little too late. The ship called their business will sink, and they will wallow in worry as they try to wonder: what went wrong?
Of course, it is not necessary that they will see a decline in demand. People may be ready to pay an arm and a leg to purchase a particular item, even if the product’s price has been increased by a tenfold. The firm will not see a drop in their profits even after exponentially raising the price!
How? How can one business fall apart with a mere increase of $10, and another raise the price by even $1000 and still have just as many, if not more, consumers? It all boils down to one economic concept: Price Elasticity of Demand.
Price elasticity of demand is a determinant of the change in quantity demanded of a particular product caused by a particular change in price. These changes are generally measured in percentages, and the scale ranges from -1 to +∞.
This is an extremely valuable tool for companies to value their products, especially in a competitive market setting. When there is a market where more than one firm is offering a similar product, also known as homogeneous product markets, then firms fight for competitive pricing and offering the most cost-effective product to the consumer.
There are several different types of markets in the economy, such as Perfectly Competitive markets, Monopoly and Monopolistic markets, and Oligopolies, among many others. These are the most common market settings that we find in the real world.
Most private firms dream of becoming monopolies, because the instant that a firm becomes a monopoly for a necessity good, you can increase the price of the product, and consumers will have no option but to buy from you. In this way, the profits soar through the roof, because most private firms have their primary objective as profit maximisation.
However, it is not often that we find pure monopolies in the world. Instead, a more common occurrence would be the oligopoly market structure. An oligopoly market is a market where a handful of firms dominate the sector, with the mobile phone industry as the most potent example. Highly popular brands like Apple and Samsung steal a majority of market share, and many up-and-coming brands are following suit, such as Vivo, Mi, and Huawei.
An oligopoly of such a kind, of course, has competitive pricing, but a more decisive influencing factor here is brand loyalty. Many families would be ready to pay a much higher price for the same product, as long as it has the label of the brand they are loyal to. This brand loyalty is built over years of hard work, and the image of the company. In today’s world, corporate social responsibility plays a significant role in determining the public image of a brand. If a company is responsible and transparent with its consumers, they automatically gravitate towards its products.
When there is such a level of trust, the firm can easily increase their products’ prices and still see a phenomenal performance in terms of profits. Once again, however, this is measured using the price elasticity of demand for the product. Along with Price Elasticity of Demand, firms use many other tools to determine prices, such as Income Elasticity of Demand and Cross-Price Elasticity of Demand. Companies make their pricing decisions for products in this manner, and it is time to break the beliefs that increasing prices will always lead to increased profits.
