Business Economics
Group Assignment
November 17th 2006
Jibran Ahmed
Chierusaku Anyanwu
Sanket Deshpande
Saima Khaliq
Besart Robo
Annamalai Subramanian
Question 1
Explain whether a business that is making losses should raise its prices
From figure 1 we can see that for a business to be making losses, it must be selling a quantity Q at a lower price than P1; the average total cost (ATC) of producing Q. However, in the short run, and providing that the business has sunk fixed costs, it is possible for the firm to continue to earn profit if price is greater than P2; the average variable cost (AVC) of producing Q. Any price below P2 incurs a loss. When analysing whether or not this business should raise its prices, we first need to consider whether it is in a perfect or imperfectly competitive market.
In a perfectly competitive market, the price of a product is constant and set by the market, creating the horizontal demand curve D1. Here we can see that even an infinitely small change in price will cause a complete loss of sales. Hence a business in perfect competition that is making losses as described above has no option but to shut down, as it cannot change its prices to increase revenues.
In an imperfectly competitive market, price effects the quantity sold; the higher the price, the lower the quantity, hence the downward-sloping demand curve D2. If a company is making losses, the decision of whether or not to raise prices now depends on the price elasticity of demand, which is classified as the percentage change in output divided by the percentage change in price. If the elasticity is less than one, the company should raise its prices as the quantity lost will be less than the pr ...