It is possible to describe the price of a good as the monetary value added by the company to a good or a service and also the money which a customer is prepared to pay to be served. The consumer may be either a goods buyer (B2B) or a finished product or service user (B2C). The clients of a company want their needs fulfilled by purchasing the product or service, but firstly they need to weigh some variables to decide the amount of money they are able to invest or what price they are ready to pay to satisfy this set of needs. The customer in most cases is looking forward to affording the good or service at the lowest price possible. Therefore, the price of a commodity plays a crucial role in determining if a customer is willing to purchase from a business or not. A business can increase its value either through increasing the perceived benefits of their commodities or reduce the perceived costs of their goods or service to enhance the willingness of a customer. Determining the price of a service or good is an important marketing decision that the management of a business must consider.
Price, Demand, and Profit
According to Yang et al. (2011, p.484), the price that a business attached to a product or service is important as it affects the revenues of the company which has an impact on the profits of the business. Therefore, the price can lead to the growth or demise of the business. On the other hand, price serves another important part of the marketing strategy of the business. Baumol and Blinder (2016, p.105) state that prices represent the assessment of the value customers attaches towards a product or service. Therefore, depending on the price elasticity of a product, the price will affect the sale and demand such that a wrong price tag can have a seriously negative influence on sales and cash flow. Also, a price that has been set too low or one set too high limit the growth of the business as the sales and demand will be substantially limited.
A business that is focusing on decreasing the unit costs must first weigh the fixed unit-manufacturing cost against the returns that will be possible for the enterprise. Some optimal level of unit cost reduction is expected to produce additional returns, and this has made marketing personnel to become focused on the pricing of their commodities to generate sales revenues. Therefore, getting the pricing right is one of the most efficient ways that an enterprise can realize maximum profits since the right price can help boost profit. Similarly, setting the wrong price can shrink a business. The management of business needs to put in place initiatives to improve pricing as the leverage and payoffs are high.
In a normal supply and demand curve, the supply slopes upwards while the demand slopes downwards. As prices increased, the supply increases as the suppliers produce more commodities. On the demand curve, as the prices increase, the demand for the commodities decreases significantly as consumers buy less. The curves intersect at a point where the demand and supply are the same, the market-clearing price.
The pricing and demand of a commodity are determined by the demand curve. According to Baumol and Blinder (2016, p.107), when the demand curve of a business is perfectly inelastic, the demand for the product or service will remain the same at both a higher and lower price. On the other hand, when the demand curve is perfectly elastic, the demand for the commodities will reduce when the business increases price and demand increases when the price is lowered. According to Baumol and Blinder (2016, p.105), the elasticity of demand is the ratio of change in price to the change in quantity demanded. The need for a commodity is regarded to be elastic when the number required reduces more than the increase in price while it is inelastic when an increase in the price of a product leads to a reduction in quantity demanded.
Impact of Price Elasticity of Demand for Profits
A business must stay away of whether an increase or decrease in the price of its product or service will increase or decrease the request and its total revenue. A price elasticity of demand is important as it provides a straightforward and easy to understand guide. As stated earlier, if the demand for a product or service is elastic, a decrease in its price will cause an increase in the total profits while if the demand is unit-elastic, a price reduction will not have a significant impact on the total revenues of the business. If the demand is inelastic, a decrease in price will reduce the total revenue. The relationship between the profits (total revenue) and the elasticity holds since:
Total Revenue = Price × Quantity Demanded
A drop in the price of the commodity will have two opposing effects as it can either decrease the profits of the business since the consumer spending on each unit of the product is cut down, or it can increase the profits as the number of units that the firm sells are raised. However, it is important to note that in some cases when the price of a product goes down, the quantity demanded will increase by the same percentage which leads to the two effects canceling out and the total revenue of the business will remain constant. To determine the demand elasticity of a good or service, several factors must be considered that affect the sensitivity of the consumers of the commodity to changes in its price.
Nature of the Good
Basic goods such as foodstuffs, their demand is inelastic, and price change has no much impact on their demand. Therefore, the profits of a business dealing with this kind of goods remains the same even with a price decrease. The demand of coking coal a basic commodity was not impacted by changes in prices for a long period of time (Tseng, 2012). The market was constrained by the supply of the commodity for a long period. On the other hand, luxury goods have an elastic demand curve where a decrease in the price of these goods is expected to increase their demand and will increase the total revenue. Specialty goods have an elastic curve since these products are unique and customers are motivated by these unusual characteristics to get them. A decrease in price will greatly increase the demand and total revenues of specialty goods such as exotic perfumes or designer clothes. Giffen goods are the inferior products that have no readily available substitutes. Therefore, a decrease in their price will have an increase in their demand. According to Doiron and Kalb (2005, p.26) services such as childcare are impacted by the change in price. An increase in the prices of these services causes a reduction in the participation of parents.
Availability of Close Substitutes
Availability of substitutes is another important factor to consider before increasing or decreasing a product. If consumers have easy access to a substitute product, an increase in price will make them readily change. Therefore, the demand for such products is elastic. Products that are more broadly defined such as grocery items is less elastic. Luxury goods have available substitutes, and an increase in the price will not have much impact on their demand. Specialty goods have no available substitutes since they are unique products and a decrease in price will increase their demand and total revenue. A reduction in the price of a commodity has a significant increase in the profit for the shareholders as there is more demand for the same product. A price reduction will have a significant boost in the profits depending on the price elasticity of the products. In Australia, beer and spirits consumptions were influenced by the presence of substitutes while wine which is a unique commodity was not greatly impacted (Selvanathan & Selvanathan, 2004).
Price Reduction in Business to Consumer and Business to Business Market
Business to business (B2B) market is more complicated than the business to consumer (B2C) since a B2B market involves a business buyer who needs to buy products or services that are significant to their company to help them stay profitable, successful, and competitive. In the market, consumers make their buying decisions basing on the quality of the product, comfort, security, and their social status while the business buyers base their buying decisions on enhancing productivity, reducing costs, and increasing profitability (Desjardins, 2014, p.94). Therefore, a business requires doing more complex research to ensure that a reduction in the price of their commodity serves the right purpose for the business by increasing their profits. Consumer markets differ from business markets in some ways. In a consumer market, there is a large number of buyers, products are produced in mass, and the perceptions of the consumers on the product determine the value and price of the product. This market operates through retail strategies since the selling and buying process is short. A B2B market has fewer customers, and it involves large transactions. The clients in this market need more customized products or services and quantity that makes their prices more personalized. The companies have to communicate their price reductions strategy to each customer hence a decrease in price would not have a significant impact on the demand as the price matches with the value of goods that the business delivers to each customer.
The price of a product or service plays a key role in its demand in the market. Demand is not fixed as it is influenced by factors such as the price of products and services. Therefore, if the variables are altered, the market shifts and impacts the total revenues. Businesses have to make crucial price decisions depending on their demand elasticity. Elasticity and profits of a business are related since the total revenue is equal to the price of commodity times the quantity demanded. Firms that have an elastic demand will have their profits increase if they reduce the price of their product. An elastic demand curve indicates that the demand increases with reduced prices for commodities. On the other hand, if the demand is unit-elastic, a reduction of prices will not have a significant impact on the total profits since the demand remains constant. Finally, in an inelastic demand curve, a reduction in the price of products or services causes a reduction in the benefits. Therefore, an assessment of demand elasticity is important as it determines the responsiveness of the quantity demanded that impacts the price and change the revenues of an enterprise.
Baumol, W. J., & Blinder, A. S. (2016). Microeconomics: principles and policy. Boston, MA, USA: Cengage Learning
Desjardins, J. R. (2014). An introduction to business ethics. New York, NY: McGraw-Hill/Irwin.
Doiron, D., & Kalb, G. (2005). Demands for child care and household labor supply in Australia. Economic Record, vol. 81, no. 254, 215-236.
Selvanathan, E., & Selvanathan, S. (2004). Economic and demographic factors in Australian alcohol demand. Applied Economics, vol. 36, no. 21, 2405-2417.
Tseng, D. (2012). Coking coal supply catches up with demand. Metal Bulletin Daily, no. 345, 9.
Yang, C., Trumbull, W., Cushing, B., & Hwang, M. (2011). Do price increases while demand is falling indicate collusion?. Journal of competition law and economics, 7(2), 481-495.