According to economic theory, why does a business get less profit from lower prices as opposed to higher prices?I MEAN SOMETIMES A LOWER PRICE WILL ATTRACT MORE CONSUMERS.  THEREFORE YOU WOULD BE...

According to economic theory, why does a business get less profit from lower prices as opposed to higher prices?

I MEAN SOMETIMES A LOWER PRICE WILL ATTRACT MORE CONSUMERS.  THEREFORE YOU WOULD BE GETTING MORE MONEY AS OPPOSED TO A HIGHER PRICE WHERE LESS PEOPLE WOULD BUY.

Asked on by rogerarnold

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enotechris's profile pic

enotechris | College Teacher | (Level 2) Senior Educator

Posted on

The margin on a sale, otherwise known as the profit, may be very small. The price of anything must include that margin for profit. Minimizing the profit means lowering the price that may result in the price close to what the cost of a good or service might be to the business. If the price is less than or equal to cost, there is no profit and of course the business loses money and is out of business.

Price alters supply and demand. If the price increases, demand may lower. At the extreme, the price can be so high that demand approaches zero -- so there are few sales but large profit.

However, if the price decreases, demand may increase, and at the extreme, the price is so low that demand approaches infinity -- so there are many sales but small profit.

Furthermore, supply will be affected in the first case by having a glut of items; in the second, a scarcity.  But a glut tends to force price down; a scarcity forces it up!

Specifically, your question is contingent upon the item or service itself, and what value the market places upon it. Where cost is cheap -- consider a pencil for sale -- profit is small, but millions are sold.  Where cost is large -- like for a Rolls-Royce -- profit is large, but few are sold.

 

pohnpei397's profile pic

pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted on

Whether a business gets more or less profit by lowering its prices depends on what's called price elasticity of demand.  This is a measure of how much the quantity demanded goes up as prices go down (or how much it goes down as prices go up).  In other words, it's about how steep the demand curve is.

If a good's price elasticity of demand is high, that means lowering the price will actually make you more money.  The link I've provided shows you how to calculate the price elasticity of demand for a good.

Goods with elastic demands are usually ones that:

  • Cost a lot relative to people's incomes
  • Are easily substituted for
  • Aren't necessary -- easy to do without

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