Price Reduction and Profit Maximization

This assignment explores the relationship between price reduction, demand elasticity, and profit maximization. It examines the law of demand, price elasticity of demand, and the factors influencing a firm's decision to reduce prices. The analysis considers both elastic and inelastic demand scenarios, emphasizing the importance of market research and data-driven pricing strategies.

Running head: PROFESSIONAL COMMUNICATION
Professional Communication
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Table of Contents
Introduction......................................................................................................................................2
Law of demand................................................................................................................................2
Price decrease and Profit.................................................................................................................2
Price elasticity of demand and profit...........................................................................................3
Decision of price reduction..........................................................................................................5
Conclusion.......................................................................................................................................6
References........................................................................................................................................7

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Introduction
All the business firms operate in an attempt to maximize its profit. Profit refers to what is
left to the entrepreneur after making payment to all the factors of production. In other words,
profit is total revenue less total cost. Now, revenue is the volume of sale multiplied with unit
prices. Greater the revenue, higher is the profit given cost. Revenue depends on magnitude of
quantity sold and price. Change in price and quantity are interrelated and the ultimate effect on
revenue depend on the magnitude of price and quantity change that generally moves in opposite
direction.
Law of demand
Law of demand explains the relation between price and quantity holding other demand-
influencing factor constant. Law of demand states that if there is an increase in price then its
quantity demanded will decrease. A decrease in price makes the goods more affordable and
hence increases its demand1. Therefore, when business firms reduces price, the obvious
expectation is to experience a boost is quantity demanded. This will compensate the loss from
price decrease and increases profit.
Price decrease and Profit
A decrease in prices while expected to boost the demand and increase profit, this may not
be the case always. When price decreases then what will happen to demand and profit that
depends on the nature and slope of the demand curve. When price reduces, then there will be a
reduction in revenue from each unit of the product sold. Now, if quantity demanded is not
1 Cerreia-Vioglio, S., et al. Law of Demand and Forced Choice. No. 593. 2016.

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increased sufficiently to offset the reduction in revenue then profit will not increase2. This
implies the increase in quantity demanded should be greater than price reduction. However, how
much quantity demanded change when price changes that depends on the elasticity of demand.
Price elasticity of demand and profit
Price elasticity of demand measures the change in quantity demanded expressed in
percentage term for a percentage increase or decrease price. Slope of the demand curve depends
on the price elasticity of demand. Depending on the percentage change in demand with a price
change, there are different types of elasticity3. When demand does not changes at all with price
change then demand is perfectly inelastic in nature. In this case, slope of the demand curve is
zero and demand curve is vertical, parallel to price axis. With a perfectly inelastic demand
curve, customers do not change their volume of purchase. They purchase same quantity of goods
and services at a higher or lower price. In this situation price increase, increases profit.
An opposite side of this is perfectly elastic demand. Here, for a slight change price
consumers change their demand infinitely. Change in price here assumed to be almost zero.
Elasticity in this case is infinity and demand curve is a horizontal straight line, parallel to
quantity axis4. If firms slightly increase their price then customers will probably buy nothing
from them.
2 Tisdell, Clement Allan. The theory of price uncertainty, production, and profit. Princeton
University Press, 2015.
3 Varian, Hal R. Intermediate Microeconomics: A Modern Approach: Ninth International
Student Edition. WW Norton & Company, 2014.

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The two cases described above are the extreme cases. Most business firms face demand
in between the two extreme types of demand. The product a firm is selling has either a relatively
elastic or a relatively inelastic types of demand curve5. For a relatively elastic demand, demand
respond to a greater proportion when price changes. Percentage change in quantity demanded is
greater than the percentage change in price. The measure of price elasticity here is greater than
one. In this situation, if firm reduces its price then demand will increase more than the
percentage price change in price. Consequently, revenue will increase and so is the price.
Relatively inelastic demand is a type of demand where quantity cannot change much when price
changes. Here change in quantity demanded is less than the proportionate change in price.
Measure of elasticity is less than one here6. When firm’s product demand is inelastic in nature,
then if firm reduces it price then quantity increase in demand will be less than price decrease.
The firm losses from price reduction as demand increase fails to compensate reduction in
revenue from the price decrease. In this case, profit will not increase from price decrease.
4 Nicholson, Walter, and Christopher M. Snyder. Intermediate microeconomics and its
application. Cengage Learning, 2014.
5 Li, Zhen, and Katsutoshi Yada. "Why do Retailers End Price Promotions: A Study on Duration
and Profit Effects of Promotion." Data Mining Workshop (ICDMW), 2015 IEEE International
Conference on. IEEE, 2015.
6 Anderson, Eric, Nir Jaimovich, and Duncan Simester. "Price stickiness: Empirical evidence of
the menu cost channel." Review of Economics and Statistics 97.4 (2015): 813-826.

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Decision of price reduction
Therefore, the decision of whether to reduce price or not should be takes only after proper
estimation of demand curve. When, firms do not know about how demand is going to be changed
then prediction should be made depending on market survey7. For this purpose, selection should
be made on customers currently purchasing the product that the customers involve in the sales
cycles. The objective here is to determine how many units current consumers are purchasing and
how their buying behavior changes with a increases and decrease in prices by the certain
percentage say x%. The survey result then should be analyzed in a supply demand framework.
This is plot the obtained data point to determine the optimal price. Optimal price is one that gives
maximum profit for the business firm8. In the concerned firm has an elastic demand curve then
with a rise in prices sales volume declines substantially and with a reduction in price sales
volume increases significantly. In this case, price decline benefits the firm by raising its profit.
When demand is inelastic, then firms benefit from increasing price as consumer cannot reduce
their demand much. Therefore, there is no hard and fast rule regarding the decision for changing
price.
7 Zatta, Danilo, and Rainer Kolisch. "Profit impact of revenue management in the process
industry." Journal of Revenue and Pricing Management 13.6 (2014): 483-507.
8 Sarkar, Biswajit, Sharmila Saren, and Hui-Ming Wee. "An inventory model with variable
demand, component cost and selling price for deteriorating items." Economic Modelling 30
(2013): 306-310.

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Conclusion
The report summarizes the underlying insight behind firm’s decision for a price reduction
in order to increase sales and profits. Law of demand suggests that a decrease in price increases
demand. This does not mean price reduction always increases revenue. The effect on revenue
depends on the responsiveness of demand when price change. This is called price elasticity of
demand. In case of elastic demand, the decision of price decrease increases profit by increasing
revenue. With inelastic demand, the decision of price increase is more beneficial because of low
responsiveness of demand. Therefore, proper market survey is needed before taking any decision
about the movement of price.

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References
Anderson, Eric, Nir Jaimovich, and Duncan Simester. "Price stickiness: Empirical evidence of
the menu cost channel." Review of Economics and Statistics 97.4 (2015): 813-826.
Cerreia-Vioglio, S., et al. Law of Demand and Forced Choice. No. 593. 2016.
Li, Zhen, and Katsutoshi Yada. "Why do Retailers End Price Promotions: A Study on Duration
and Profit Effects of Promotion." Data Mining Workshop (ICDMW), 2015 IEEE International
Conference on. IEEE, 2015.
Nicholson, Walter, and Christopher M. Snyder. Intermediate microeconomics and its
application. Cengage Learning, 2014.
Sarkar, Biswajit, Sharmila Saren, and Hui-Ming Wee. "An inventory model with variable
demand, component cost and selling price for deteriorating items." Economic Modelling 30
(2013): 306-310.
Tisdell, Clement Allan. The theory of price uncertainty, production, and profit. Princeton
University Press, 2015.
Varian, Hal R. Intermediate Microeconomics: A Modern Approach: Ninth International Student
Edition. WW Norton & Company, 2014.
Zatta, Danilo, and Rainer Kolisch. "Profit impact of revenue management in the process
industry." Journal of Revenue and Pricing Management 13.6 (2014): 483-507.