Impact of Price Drop on Demand & Profit

This essay examines the relationship between price drops and their impact on business demand and profit. It begins by introducing the law of demand and its exceptions, such as Giffen goods and Veblen goods. The essay then delves into various factors influencing demand, including consumer income, preferences, speculation, and future expectations. Different types of goods, including essential goods and normal goods, are analyzed to illustrate how price drops affect their respective demands. The essay concludes that while price drops can increase demand and profit for normal goods, exceptions exist due to consumer behavior and market dynamics. The impact of price drops is not always straightforward and depends on several factors, making it crucial for businesses to understand these nuances before implementing pricing strategies.

Running head: IMPACT OF PRICE DROP ON BUSINESS DEMAND & PROFIT
IMPACT OF PRICE DROP ON BUSINESS DEMAND & PROFIT
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1IMPACT OF PRICE DROP ON BUSINESS DEMAND & PROFIT
TABLE OF CONTENT
INTRODUCTION......................................................................................................................2
DISCUSSION............................................................................................................................2
DEMAND HABITS OF GIFFEN GOODS...............................................................................3
DEMAND HABITS OF VEBLEN GOODS.............................................................................3
SPECULATIVE DEMAND......................................................................................................4
ADVERSE FUTURE EXPECTATION....................................................................................4
DEMAND HABITS OF ESSENTIAL GOODS........................................................................5
DEMAND HAHBITS NORMAL GOODS...............................................................................5
CONCLUSION..........................................................................................................................5
REFERENCE.............................................................................................................................6

2IMPACT OF PRICE DROP ON BUSINESS DEMAND & PROFIT
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

3IMPACT OF PRICE DROP ON BUSINESS DEMAND & PROFIT
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

4IMPACT OF PRICE DROP ON BUSINESS DEMAND & PROFIT
D
P2
P1
Q1 Q2
P
Q
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.
Figure 1: Demand under Veblen Effect
(Source: Author)

5IMPACT OF PRICE DROP ON BUSINESS DEMAND & PROFIT
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 won’t 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.

6IMPACT OF PRICE DROP ON BUSINESS DEMAND & PROFIT
D
P2
P1
Figure 2: Demand for Essential Goods
(Source: Author)
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

7IMPACT OF PRICE DROP ON BUSINESS DEMAND & PROFIT
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.

8IMPACT OF PRICE DROP ON BUSINESS DEMAND & PROFIT
REFERENCE
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.

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