Here’s a very simple spreadsheet
showing that as you put your price up the quantity sold drops off in an exponential way (the red line)
Your turnover (or income) is price x quantity sold – the green line
Your cost depends on how many you sell (the purple line)
Your profit is turnover (income) minus costs – the light blue line
See how it is low when you are very cheap because the income isn’t there, and low when you are very expensive because the sales aren’t there. It is maximised in the middle.
But how can you know where the middle is when you are just out there quoting prices to people? How do you know if you are at the middle?
Notice how the point of maximum profit (£520) is at a price of 10, where you are selling 65 units. Compare this 65 with the amount you’d sell if your price was so cheap that nobody turned you down, you got every sale you could, i.e. 190 units. So you are are losing about 2/3 of your business on price when you are maximising your profit! It’s a painful feeling to lose all those potential sales, but it makes sense.
Are YOU losing 2/3 of your business on price? Maybe you should be!
- You can play around with how exponential the demand curve is, it makes almost no difference
- You can play around with the amount of cost, it makes almost no difference
- You can play around with the elasticity, it makes a difference to you sales and profit but the maximum point is not affected at all
- You can add fixed costs – they reduce your profit flat across the board, and don’t affect where the maximum point is
Onwards and upwards!