What this lesson teaches
I can explain the strategies firms use to raise revenue or cut unit costs: growth, pricing, price discrimination, innovation, marketing and collusion.
Syllabus 9570, 2.2.3(a). Firms' Decisions and Strategies: Firms make decisions and engage in pricing, cost and product differentiation strategies aimed at raising revenue and/or lowering unit costs. These include:; growth, diversification and shut-down; price competition; third degree price discrimination; innovation, research and development; marketing; collusion with other firms
Make a guess
A cafe spends $50,000 a year on advertising to stand out from rivals. Must its profit rise?
- Yes. Advertising always raises a cafe's profit.
- No. Advertising never brings in any new customers.
- Only if it adds over $50,000 in revenue.
Show the answer
Only if it adds over $50,000 in revenue.
Advertising can raise demand and make it less elastic, but it is a cost. Profit rises only if the revenue it brings beats the cost.
Making a product different from rivals' can raise demand and make it less price elastic.
Product differentiation makes a firm's product distinct, through quality, design, location, service or branding.
If it works, demand rises and becomes less price elastic, because customers see fewer close substitutes. On a firm diagram, AR shifts right and becomes steeper, and MR moves with it. Where MR = MC, the firm can now charge a higher price, and its supernormal profit grows.
Marketing can inform customers about real differences, or persuade them through branding and advertising.
Both raise costs: advertising and design are paid for whatever happens to sales, so AC shifts up. The strategy raises profit only if revenue rises by more than costs. Rivals can copy good ideas, so the advantage may not last.
- Aim
- Shift AR right and make it less elastic.
- Diagram
- New MR = MC gives a higher price; profit is the rectangle between price and AC.
- Risk
- Costs money and raises AC; rivals may copy.
Worked example: Reliable appointments or celebrity ads?
A repair shop's customers complain about long waits. It can spend the same amount on guaranteed appointment times or on a celebrity advertising campaign.
- Guaranteed appointments fix a real problem, so customers may stay loyal and recommend the shop.
- Celebrity ads may raise awareness but do not improve the service.
- Both could raise demand; the first is more likely to make it less elastic, since it is harder for rivals to match.
- The shop should test which brings more repeat customers before committing.
Watch out for this
Advertising always increases profit.
Advertising costs money, and rivals may respond with their own campaigns. Profit rises only if the extra revenue exceeds the cost.
Check your understanding
A bubble tea brand builds a strong following for its unique flavours. What is the likely effect on its demand?
- Supply shifts right, because the brand can now sell more cups.
- Demand rises and becomes more price elastic, as more people try it.
- Demand rises and becomes less price elastic.
Show the answer
Demand rises and becomes less price elastic.
Right. Fans see fewer close substitutes, so they buy more and are less sensitive to price.