Many businesses are unable to make accurate projections for the future, whether it be because of a lack of information or inconsistent data. For example, a business management company that uses a price that is too low will not make enough money to sustain itself, and resources will run out.
On the other hand, if the price is set too high, then no customers will buy the product leading to an overall loss for the company. As both scenarios lead to negative outcomes, businesses seek to find a price point that brings about an equilibrium.
Both under-pricing and overpricing are bad for business, resulting in lower turnover and lower profits, respectively.
Underpricing
Pricing products too low results in operating costs being greater than the revenue generated from sales. This can be described as ‘subsidy by the owner.’ Eventually, the position becomes unsustainable as costs are not covered, and further losses are incurred.
Overpricing
Overpricing can lead to a similar outcome by making customers unwilling to purchase the product. If customers cannot afford the price, they will look for an alternative product instead of buying this one – this results in lost sales and leads to both revenue and market share being lost.
Break-even point
The levels of these negative outcomes which businesses seek to avoid are known as the ‘break-even point,’ where operating costs and revenues from sales become equal, and no net financial loss is made.
The break-even point is different for each company due to differences such as capital values, revenue values, etc. Break-even points can change depending on certain variables too. For example, if a company invests in machinery that decreases production costs, the break-even point will decrease as costs drop.
Finding an equilibrium price can be difficult for businesses; there are many factors that need to be taken into consideration when making the decision, such as market size and competition, etc.
Businesses may use different prices during different times of the year depending on the demand for products. For example, a business management company may offer discounts at certain times to attract more customers, known as ‘price discrimination.
Price discrimination is used widely by multi-national companies as it allows them to maximize profits from each customer regardless of the country or region they reside in.
The equilibrium price is a balance between the two forces of demand and supply.
Demand:
The amount of goods or services that customers are willing to buy at different prices, considering factors like their income levels, preferences, and expectations about future prices. The quantity demanded will decrease as the price increases because people will buy less.
Supply:
A measure of how many units of something is available for purchase in a market at various prices—the higher the price, the fewer can be sold. The quantity supplied will increase as the price increases because producers are willing to sell more units.
If this graph represents demand, it slopes downward from left to right; if it represents supply, it slopes upward from left to right because producers are willing to sell more units when the price is low, and when it’s high, they’re less willing.
At a given price in a market with no government intervention: The quantity demanded is equal to the quantity supplied. This is known as an “equilibrium” because both forces of demand and supply have reached equilibrium—they’re balanced. At equilibrium, there will be no pressure for either force to change its rate of doing business.
In conclusion
Businesses seek an equilibrium price due to associated risks with both overpricing and underpricing. Prices should be set at a level that returns a profit while not being too low to make the company unsustainable or too expensive for customers.
Seeking an equilibrium price is a delicate balance where risks and rewards are weighed against each other to determine the best course of action.
