7. The price system and the microeconomy

Total utility is the satisfaction from consuming a given quantity. Marginal utility is the change in total utility from consuming one additional unit: MU = change in TU divided by change in quantity.

If marginal utility is positive, total utility rises; if it is zero, total utility is at a maximum; if it is negative, total utility falls. The law of diminishing marginal utility says successive units often add less satisfaction, holding other conditions constant.

If total utility rises from 40 to 52 when consumption increases from 2 to 3 units, marginal utility of the third unit is 12 utils.

Diminishing marginal utility does not mean total utility immediately falls, and utility is an analytical measure rather than a directly observed physical substance.

Diminishing marginal utility means that, as consumption of a good increases, the marginal utility of each successive unit tends to fall, holding other conditions constant.

Total utility can still rise while marginal utility is positive. Once marginal utility reaches zero, total utility is at its maximum; if marginal utility becomes negative, total utility falls. The pattern supports a downward-sloping demand curve in the simple model.

The first cup of water to a thirsty person may add 20 utils, the second 12, and the third 5. Total utility is still increasing, but each extra cup matters less.

Diminishing marginal utility is not the claim that every good always has the same numerical pattern or that total utility immediately decreases.

The equi-marginal principle says a consumer allocates spending so that the marginal utility gained from the last unit of money is equal across goods: MUx/Px = MUy/Py, subject to the budget.

If one good gives more utility per dollar, shifting a small amount of spending toward it raises total utility until the ratios equalise or a corner solution is reached.

If the next unit of tea gives 18 utils at $3 (6 utils per dollar) and fruit gives 8 utils at$2 (4 utils per dollar), the consumer should shift spending toward tea before claiming the bundle is optimal.

The rule compares marginal utility per price, not total utility or marginal utility alone, and it assumes the prices and preferences used in the calculation are relevant.

A consumer’s individual demand curve shows the quantity chosen at each possible price, holding income, preferences and other relevant prices constant.

At each price, the consumer chooses the affordable bundle that maximises utility. A lower price changes the budget constraint and the marginal-utility-per-price comparison, producing a new chosen quantity. Joining those price-quantity choices gives the curve.

If the price of coffee falls while income and tea’s price stay fixed, coffee becomes more attractive per dollar and the budget line rotates outward around the tea intercept; the optimal coffee quantity may rise.

A movement along a demand curve is caused by the good’s own price; a change in income or preferences shifts the curve instead.

The marginal-utility model is useful for explaining choice, but it simplifies preferences, information and measurement. Utility units are analytical devices, not directly observable physical quantities.

The model may assume stable preferences, rational choice, divisible goods, diminishing marginal utility and independence between goods. Complements, substitutes, habits, uncertainty and behavioural biases can weaken the simple prediction.

A collector may value a tenth item more than the first because of a set-completion effect, contradicting a strict diminishing pattern while leaving the model useful for other goods.

A model assumption is not an empirical law; use the theory to predict under stated conditions rather than treating every deviation as a calculation error.

An indifference curve contains combinations of two goods that give the consumer the same satisfaction. A budget line contains combinations that exhaust income at given prices.

For standard preferences, indifference curves are downward sloping and convex because the marginal rate of substitution usually falls. The budget line’s slope reflects the relative prices; its intercepts reflect income divided by each price.

If income is $60 and prices are$10 for X and $5 for Y, the intercepts are 6 units of X and 12 of Y. Any point inside is affordable but leaves income unspent.

An indifference curve is not a demand curve, and points on a higher curve are preferred only if the curves represent the same preferences and are reachable.

A rise in income shifts the budget line outward in parallel; a fall shifts it inward. A change in one good’s price rotates the line because one intercept changes while the other stays fixed.

The slope changes with relative prices, not with income. The new best affordable bundle depends on preferences, so the same budget-line movement can produce different quantities for different consumers.

If income rises from $60 to$80 with prices unchanged, both intercepts increase by one-third. If X’s price falls while Y’s price stays fixed, the X-intercept moves outward and the Y-intercept is unchanged.

A parallel shift is not caused by a single price change, and a budget-line change alone does not tell you whether demand for a good rises or falls.

When the price of a good changes, the consumer’s choice changes for two reasons. The substitution effect replaces relatively expensive goods with the now relatively cheaper good; the income effect changes real purchasing power.

For a normal good, a price fall usually raises demand through both effects. For an inferior good the income effect works in the opposite direction; for a Giffen case it could be so strong that demand falls when price falls, although this is unusual.

A cheaper bus ticket makes bus travel cheaper relative to taxis and also leaves the household with more real purchasing power. Both channels can raise bus journeys, but a normal-good assumption is doing work.

The income effect is not simply a cash-income change, and the substitution effect is not “switching because preferences changed”.

The standard indifference-curve model assumes coherent preferences, complete information, divisible goods, a fixed income and prices, and curves that are ordered and usually convex.

Real choices may involve uncertainty, habits, status, discrete purchases, changing preferences, imperfect information or behavioural biases. Perfectly straight or kinked curves can represent special cases such as perfect substitutes or complements.

A commuter cannot buy 0.3 of a bus journey, and a loyalty habit may keep them with a familiar provider even after the relative price changes; the smooth-curve prediction is then only an approximation.

The model’s elegance is not evidence that people literally calculate utility; it is a conditional tool for analysing trade-offs.

Productive efficiency occurs when output is produced at the lowest possible average cost, often where a firm operates at minimum AC. Allocative efficiency occurs when output matches what consumers value at the margin, represented by P = MC in a competitive model.

A market can satisfy one condition without the other. A monopoly may exploit economies of scale and be productively efficient yet restrict output so price exceeds marginal cost.

If a firm produces at the bottom of its average-cost curve but charges a price above marginal cost, it minimises cost per unit but does not allocate resources according to marginal willingness to pay.

“Efficient” is incomplete unless you specify productive, allocative or another criterion; minimum average cost is not the same as P=MC.

The usual productive-efficiency condition is output at minimum average cost. The usual allocative-efficiency condition is price equal to marginal cost, because the value of the last unit equals the resource cost.

These are model conditions, not universal laws. Externalities require social rather than private marginal cost or benefit; public goods and information problems may prevent the simple market result.

If a factory’s minimum AC occurs at 1,000 units but its price is above MC at that output, it is productively efficient but allocatively inefficient in the basic model.

Do not apply P=MC mechanically when external costs, market power or non-price allocation means the relevant social curves differ from private curves.

An allocation is Pareto efficient when there is no feasible change that benefits at least one person without harming anyone else. It is a criterion about possible improvements, not a judgement that the outcome is fair.

Many unequal allocations can be Pareto efficient because changing them would hurt someone. Pareto efficiency also says nothing about who has power, basic needs or equal opportunities.

A redistribution from a wealthy person to a poor person may improve welfare but fail the strict Pareto test because the donor is worse off, even if society regards the change as fair.

Pareto efficient does not mean socially optimal, equal or morally desirable; it only rules out a particular kind of mutually non-harmful improvement.

Dynamic efficiency concerns whether firms and markets improve products, processes and productive capacity over time, often through investment, research and development and learning.

A temporary loss of static allocative efficiency may be defended if retained profits finance innovation. The claim must be tested: market power can provide resources for R&D, but it can also weaken the pressure to innovate.

A patent-protected firm may charge above marginal cost today while investing in a lower-cost production method that becomes available later. Whether this is dynamically efficient depends on the size and persistence of the innovation.

Dynamic efficiency is not simply “any investment”, and a monopoly is not automatically dynamically efficient; compare innovation benefits with exclusion and pricing costs.

Market failure occurs when the market allocation of resources is inefficient, so the social benefits and costs of output are not correctly reflected in private decisions.

The result may be too much, too little or the wrong composition of output. Externalities, public goods, information gaps, market power and missing markets are common mechanisms; identify which one prevents the price system from coordinating resources.

If a factory’s pollution harms neighbours without appearing in its costs, the market can produce more than the socially efficient quantity.

Market failure does not mean the market produces zero output or that every government intervention improves welfare; compare the likely policy failure too.

Market failure can arise from external costs or benefits, non-rival or non-excludable goods, asymmetric information, market power or a missing market.

The diagnosis determines what is unpriced or misallocated. A Pigouvian tax may address a measurable external cost; information disclosure addresses knowledge; competition policy addresses market power. The same symptom can have different causes.

A shortage of vaccinations may reflect an external benefit rather than a monopoly. A single dominant supplier may instead restrict output even when no spillover exists.

Do not label every high price “market failure”, and do not choose a subsidy before explaining which social marginal curve is missing from the market decision.

Social cost is the total cost imposed by an activity on society: private cost paid by the decision-maker plus any external cost imposed on third parties. In symbols, MSC = MPC + MEC.

When an external cost is positive, marginal social cost lies above marginal private cost. If consumers and firms consider only private cost, market output is higher than the socially efficient quantity.

A delivery vehicle pays fuel and labour costs, but its congestion and emissions impose costs on others. Those external costs make the social cost of an extra delivery higher than the firm’s private cost.

Social cost is not the government’s budget cost and should not be counted twice if the private payment already compensates the affected party.

Social benefit is the total benefit to society: private benefit received by the consumer plus any external benefit received by third parties. In symbols, MSB = MPB + MEB.

With a positive external benefit, the social marginal benefit curve lies above the private marginal benefit curve. If buyers consider only private benefit, market consumption is below the socially efficient quantity.

A vaccinated person receives private protection, while lower transmission benefits others. The external benefit makes the social value of an extra vaccination greater than the individual’s private value.

A positive externality is not simply a product that is popular; it requires a benefit spilling over to people outside the transaction.

A negative externality imposes an uncompensated cost on a third party; a positive externality gives an uncompensated benefit. They can arise in consumption or production.

The key test is whether the affected person is outside the buyer-seller decision and whether the spillover is omitted from the market price. Negative externalities usually cause overproduction or overconsumption; positive ones cause underproduction or underconsumption.

Noise from a nightclub is a negative consumption or production spillover depending on the source. A firm’s research that other firms learn from creates a positive production spillover.

Externality signs are about the direction of the spillover, not whether the activity itself is “good” or “bad” in every context.

A negative production externality makes MSC exceed MPC, while a negative consumption externality makes MSB fall below MPB. Positive externalities reverse the relevant gap.

Label the private and social curves first, then compare the market intersection with the social intersection where MSB = MSC. The diagram shows the direction of misallocation; it does not by itself choose the best policy.

If education creates benefits for classmates, MSB lies above MPB and the market consumes too little. If a chemical factory pollutes a river, MSC lies above MPC and the market produces too much.

Do not shift both curves automatically: production spillovers change cost, consumption spillovers change benefit, and some activities can contain both.

Deadweight welfare loss is the net social surplus lost when output differs from the efficient quantity. Mutually beneficial trades are missed, or resources are used where their social cost exceeds their social benefit.

On a standard diagram it is the area between the relevant marginal social benefit and marginal social cost curves over the units between market and efficient output. The shape and size depend on elasticities and the gap.

A monopoly that restricts output below the point where P=MC creates a triangle of lost surplus: consumers who value an extra unit above its cost cannot buy it.

A transfer from consumer to producer is not automatically deadweight loss; the loss is the surplus that disappears, not merely who receives it.

Asymmetric information exists when one party knows more relevant information than another. Moral hazard occurs when someone takes more risk because another party bears part of the consequences after an agreement.

Before a transaction, hidden information can cause adverse selection; after it, hidden action can create moral hazard. Monitoring, contracts, deductibles and disclosure can reduce—but not always remove—the problem.

An insured driver may take less care because the insurer covers much of the loss. A larger excess or monitoring device makes the driver face more of the marginal cost.

Moral hazard is not simply dishonesty and does not require a hidden type; it is a changed action caused by the incentive structure after protection is provided.

Cost-benefit analysis estimates the social costs and social benefits of a project, including external effects that do not have a market price. A project is worthwhile in the basic test when estimated net social benefit is positive.

Analysts must define the counterfactual, value time, uncertainty and distribution, and avoid double counting. Shadow prices or stated preferences may be used for non-market effects, but they are estimates rather than exact facts.

A new rail line has construction and operating costs, time savings, fare revenue, congestion relief and noise. Counting only ticket revenue would understate the social benefit; counting both time savings and an already included wage payment could double count.

A positive net present value is not a guarantee: assumptions, discount rate, distribution and omitted risks can change the decision.

A short-run production function shows the maximum output obtainable from variable inputs when at least one factor—often capital—is fixed. Total product is output; average product is output per unit of the variable input; marginal product is the extra output from one more unit.

As more variable labour is added to fixed capital, marginal product may first rise through specialisation and then fall because the fixed factor becomes a constraint. This is the law of diminishing marginal returns.

One worker at a machine may produce 10 units; a second may produce 24 through teamwork; a fifth may produce only 4 extra because workers crowd the same machine.

Diminishing marginal returns is a short-run concept and does not mean total product immediately falls.

In the short run, total cost equals total fixed cost plus total variable cost. Average cost is total cost per unit; marginal cost is the extra cost of one more unit.

Fixed cost does not vary with output in the chosen period, while variable cost does. Average fixed cost falls as output rises; marginal cost eventually rises when diminishing marginal returns make extra output require increasingly more variable input.

Rent of 1,000 is fixed. If variable cost is 600 at 100 units, total cost is 1,600 and average total cost is 16; a later unit’s cost is measured by the change in total cost, not by average cost.

Fixed cost is not zero when output is zero, and marginal cost is not total cost divided by output—that is average cost.

In the long run, no factor is fixed: a firm can change plant size, capital, labour and technology. A long-run production function shows the maximum output for different combinations of inputs.

Returns to scale describe what happens when all inputs rise together: increasing returns produce a more-than-proportional output rise, constant returns a proportional rise, and decreasing returns a less-than-proportional rise.

Doubling all inputs from a small automated plant may more than double output because tasks specialise; doubling a very complex organisation may produce less than double because coordination becomes difficult.

Returns to scale are not the same as diminishing marginal returns: the former changes all inputs, while the latter changes one variable input with another factor fixed.

In the long run all factors are variable, so the long-run average cost curve shows the lowest possible average cost for each output after the firm can choose its scale of operation.

Each point is the least-cost choice among possible plants and input combinations. The curve may fall through economies of scale and rise through diseconomies; short-run average-cost curves represent individual fixed plant sizes around it.

A firm producing 1,000 units may choose a small plant, while at 10,000 units a larger automated plant has lower average cost. The long-run curve traces the least costly option at each scale.

Long run does not mean every cost disappears; it means the firm has time to adjust all inputs, and opportunity costs still matter.

Economies of scale exist when increasing all inputs causes long-run average cost to fall as output rises. Internal economies come from the firm’s own scale; external economies arise from the industry or location.

Specialisation, bulk purchasing, finance, marketing, technology and spreading fixed set-up costs can lower unit cost. The source matters because internal economies may make one firm larger, while external economies can benefit many firms in a cluster.

A large manufacturer can justify a dedicated quality team and negotiate lower input prices; a whole technology cluster can share suppliers and skilled labour, lowering costs for several firms.

A larger firm is not automatically lower cost: economies depend on output relative to the relevant scale and can be followed by diseconomies.

Internal economies of scale are reductions in a firm’s long-run average cost caused by its own increase in output or scale.

Common sources include technical indivisibilities, managerial specialisation, bulk buying, financial access, marketing spread and risk-bearing. The relevant test is whether the firm’s unit cost falls because it becomes larger.

A supermarket chain can spread a national advertising campaign across more stores and negotiate supplier discounts; those savings are internal if they arise from the chain’s own scale.

A lower price from an industry-wide technology improvement is not necessarily an internal economy, and fixed-cost spreading alone does not explain every cost reduction.

Diseconomies of scale occur when expanding all inputs causes long-run average cost to rise. They often arise from communication failures, slower decisions, weak monitoring or loss of managerial control.

The problem is not simply “being big”; it is that the additional complexity makes each unit of output more costly. Technology, delegation and organisational design can shift the point at which diseconomies appear.

A rapidly expanding firm may duplicate departments and delay decisions across layers of management, raising average cost even though it can still obtain bulk discounts.

Diseconomies of scale are different from diminishing marginal returns: all inputs can vary in the long run, whereas diminishing returns holds at least one factor fixed.

Total revenue is price multiplied by quantity sold: TR = P × Q. Average revenue is revenue per unit, TR/Q, which equals price when every unit sells at the same price. Marginal revenue is the extra revenue from one more unit.

For a price-taking firm, AR and MR equal the market price. For a firm facing a downward-sloping demand curve, selling more usually requires lowering price, so marginal revenue is below price.

Selling 100 units at $8 gives TR=$800 and AR=$8. If selling the 101st unit requires cutting the price on all units, its marginal revenue is less than$8.

Marginal revenue is not the average price, and total revenue can fall when quantity rises if the price reduction is large enough.

Accounting profit is total revenue minus explicit costs. Economic profit subtracts opportunity costs as well, so a firm can earn accounting profit but zero or negative economic profit.

Normal profit is the minimum economic profit needed to keep resources in their current use; it is included in economic cost. Supernormal or abnormal profit is economic profit above normal profit.

If revenue is 100, explicit costs are 60 and the owner’s next-best alternative is 30, accounting profit is 40 but economic profit is 10.

Zero economic profit does not mean the entrepreneur earns nothing; it means all explicit and implicit costs, including the normal return, are covered.

Total profit is total revenue minus total cost. Accounting profit subtracts explicit money costs; economic profit also subtracts opportunity costs, so economic cost includes normal profit.

Average profit is profit per unit, while marginal profit is the change in profit from one more unit. A firm maximises profit where marginal revenue equals marginal cost, provided the output is worth producing and the curves cross in the relevant direction.

If TR=$900 and explicit costs=$600, accounting profit is $300. If the owner gives up$250 by running the firm, economic profit is $50.

Do not call revenue profit, and do not compare a firm’s accounting profit with another firm’s economic profit without using the same cost definition.

Market structure is the pattern of competition in a market, shaped by the number and size of firms, product differentiation, barriers to entry and exit, information and the firms’ control over price.

The textbook structures—perfect competition, monopolistic competition, oligopoly and monopoly—are benchmarks. Real markets often sit between them, so use the features that matter rather than forcing a label.

Many small firms selling an identical commodity face different constraints from a few firms selling differentiated mobile networks, even if both are called “competitive” in casual speech.

The number of firms alone does not determine structure; barriers, product differences and strategic interdependence can be more important.

Key market-structure features include the number and relative size of firms, product homogeneity or differentiation, freedom of entry and exit, information, and whether firms are price takers or price makers.

In oligopoly, each firm must also consider rivals’ responses. In monopoly, a single supplier faces the market demand curve but may still be constrained by substitutes, regulation and potential entry.

A small wheat farm is close to a price-taking benchmark; a dominant branded platform can influence price or terms, but user switching and potential competitors limit its power.

“Price maker” does not mean a firm can charge any price and sell any quantity; demand, substitutes and strategic responses still constrain it.

A barrier to entry raises the cost or difficulty of a new firm entering; a barrier to exit makes it costly to leave. Legal protection, sunk costs, economies of scale, brand loyalty, network effects and strategic behaviour can all matter.

A barrier is economically relevant only if it changes the feasible choices of potential entrants or incumbents. Sunk costs are especially important because they cannot be recovered on exit.

A patent can delay imitation; a large network becomes more useful as users join; specialised machinery with little resale value can make exit costly even when current profits are low.

A large start-up cost is not automatically an insurmountable barrier, and economies of scale can be a barrier only when the minimum efficient scale is large relative to market demand.

Performance can be judged by profitability, productive and allocative efficiency, innovation, quality, choice, employment and consumer welfare. Market structure influences these outcomes but does not determine them alone.

A monopoly may exploit scale or fund innovation yet restrict output; intense competition may lower prices but leave little finance for research. Compare the relevant objective, period and counterfactual rather than declaring one structure always best.

A regulated utility can have one network because duplication is wasteful, while regulation or price caps address its market power. A fragmented market can still have poor quality if information is weak.

Market share is not the same as performance, and short-run low prices do not prove long-run efficiency or innovation.

An n-firm concentration ratio is the combined market share of the largest n firms, usually expressed as a percentage. A high ratio suggests a concentrated market, while a low ratio suggests many smaller firms.

Choose the market definition, measure and number of firms carefully. Concentration can signal market power, but it does not prove abuse: products may be contestable, firms may compete strongly, or the market may be defined too narrowly or broadly.

If the four largest firms have shares of 35%, 25%, 15% and 10%, the four-firm concentration ratio is 85%.

A concentration ratio is not a direct price or profit measure, and it can hide inequality among the smaller firms or changes in potential competition.

There is no single best measure of firm size. Common measures include revenue, value of assets, number of employees, output and market share.

Different measures answer different questions: employment captures labour use, sales capture turnover, assets capture capacity, and market share captures position in a defined product market. Compare firms only when the measure and market boundary match.

A capital-intensive utility may have high assets but relatively few employees; a labour-intensive retailer may have the reverse. Calling one “larger” depends on the purpose of the comparison.

A high market share is not automatically high revenue or high profit, and a firm’s size in one market may be small in another.

Internal, or organic, growth occurs when a firm increases output or capacity through its existing operations—such as new outlets, investment, product development or entering a new region.

It is usually slower and more controllable than buying another firm, and the culture and systems are easier to integrate. Funding constraints, management capacity and demand risk can limit the pace.

A bakery opens two new shops, trains staff and develops a delivery line. It becomes larger without acquiring another bakery.

Internal growth is not automatically safer: a firm can overinvest, dilute quality or enter a market it does not understand.

External growth occurs when a firm expands through merger, acquisition, joint venture or another agreement with an existing organisation. Horizontal integration joins firms at the same stage; vertical integration joins different stages of a supply chain.

Conglomerate growth crosses unrelated markets. External growth can provide scale, brands, technology or distribution quickly, but it brings purchase cost, culture clashes, duplicated assets and competition concerns.

A manufacturer buying a supplier is vertical backward integration; buying a rival is horizontal. The likely efficiency and market-power effects are different.

“Bigger after a takeover” does not prove economies of scale or success; examine integration costs, market structure and the reason for the deal.

A cartel is an explicit or tacit agreement among competing firms to coordinate prices, output, markets or other competitive conditions. It aims to increase joint profit by acting less like independent rivals.

Cartels are unstable because each member can gain by secretly cutting price or expanding output. Detection, legal penalties, different costs and changing demand also make coordination difficult.

If firms agree to restrict output and raise price, consumers face less choice and higher prices. One member may secretly offer discounts, undermining the agreement.

Parallel prices alone do not prove a cartel; firms can reach similar prices independently when they face similar costs or a common market shock.

A principal-agent problem occurs when a principal delegates a decision to an agent whose actions are difficult to observe and whose incentives may differ. Managers may pursue sales, status or job security rather than owners’ profit.

Monitoring, performance pay, ownership stakes and clear contracts can align incentives, but they also have measurement costs and may encourage gaming. Information asymmetry is central.

A manager may favour an acquisition that increases the firm’s size and prestige even if its return is weak; a long-term return measure can make the incentive more consistent with owners’ objectives.

The problem is not simply “managers are bad”; it is created by delegated control, imperfect information and incentive design.

Profit is maximised at the output where marginal revenue equals marginal cost, MR=MC, provided marginal cost is rising through the intersection and the firm covers the relevant avoidable cost in the short run.

If MR exceeds MC, one more unit adds to profit; if MC exceeds MR, reducing output raises profit. The firm then reads price or average revenue from its demand conditions and compares total revenue with total cost.

At 100 units MR=$12 and MC=$9, expanding is profitable at the margin. At 105 units MR=$10 and MC=$10, the firm stops if MC is rising beyond the intersection.

MR=MC identifies the best output, not automatically a positive profit; a firm may still minimise loss or shut down if revenue cannot cover avoidable cost.

A firm’s objective is the outcome its decision-makers try to maximise. Possible objectives include profit, sales revenue, growth, market share, survival, satisficing or social and environmental goals.

The objective depends on ownership, competition, finance, managers’ incentives and time horizon. A firm may accept lower current profit to build a customer base or protect liquidity.

A new platform may price low to gain users and network effects, while a family firm may prefer stable income and control rather than maximum sales.

“The firm” is not a single mind: objectives can conflict between owners, managers, workers and communities, and a stated mission does not prove the actual objective.

Price discrimination occurs when a seller charges different prices to different customers for the same product or service, not because the cost of supplying them differs, and prevents effective resale.

The firm needs market power and information or a way to segment customers. It usually charges a higher price to a group with less elastic demand and may use the extra revenue to expand output.

Peak and off-peak rail fares can separate commuters from flexible travellers when tickets are not freely transferable. The price gap reflects demand conditions, not necessarily different train costs.

Different prices are not automatically price discrimination: cost differences, quality differences or competitive discounts can explain them without the required market conditions.

A pricing policy is a rule for setting prices, such as cost-plus, penetration, price skimming, limit pricing, predatory pricing, psychological pricing or dynamic pricing.

The suitable policy depends on demand elasticity, costs, product life cycle, competition, capacity, legal constraints and the objective. A low introductory price may build volume, while a high launch price may recover R&D from customers with high willingness to pay.

A new technology with strong early demand may use skimming before competitors enter; a supermarket with a low-margin strategy may use penetration to build regular traffic.

A named policy does not predict success by itself; explain the mechanism and the condition that makes the price credible.

Price elasticity of demand measures the percentage change in quantity demanded divided by the percentage change in price. If demand is elastic, a price cut raises total revenue; if demand is inelastic, a price cut lowers total revenue; unit elasticity leaves revenue unchanged at the margin.

Total revenue is price times quantity. The relationship is local and depends on where the firm is on its demand curve, so do not infer it from the sign alone.

If a 10% price cut increases quantity by 20%, demand is elastic and revenue changes approximately from P×Q to 0.9P×1.2Q=1.08PQ, an 8% rise.

The negative sign in PED indicates the inverse relationship; elasticity classification uses the absolute value, and “inelastic” does not mean quantity never changes.