AOF Business Economics Unit 4, Lesson 10 Demand and Pricing Copyright © 2008–2011 National Academy Foundation. All rights reserved. A business is motivated by profit • • Firms will grow avocados only if they can make a profit To make a profit, the price must exceed the cost of growing them How much does price need to exceed cost to entice a firm to enter the market? Breaking even isn’t enough Firms won’t grow avocados unless their return on investment (ROI) is positive. One way to assess ROI is through a yearly “rate of return”: total profits divided by total investments. How much more would you have to make above total costs to launch a business? Production Cost + Opportunity Cost + How much profit = To invest or not to invest, that is the question Increased demand creates profit opportunities • The low-calorie avocado increases demand • People will buy more of them at any price $1.09 0.99 0.89 0.79 0.69 D2009 (low-cal introduced) D2008 50 100 150 200 250 When demand increases, what signal does this send to the marketplace? When demand changes, so do price and supply • When demand goes up, the supply and demand equilibrium changes, and prices rise, at least at first • Increased price means increased profit • Firms already producing avocados will produce more, AND new firms will start to grow avocados When demand goes up Price goes up How might the production from these new firms impact avocado prices? Then supply goes up Low-calorie avocados increase demand Firms respond only to the increase in price that leads to an increase in profit $1.09 S 0.99 0.89 0.79 0.69 D2009 (low-cal arrive) D2008 50 100 150 200 250 How might this impact revenue and profit next year? Supply and demand continually adjust • Profits provide an incentive for firms to start producing avocadoes, which increases supply • Increased supply means prices will fall $1.09 0.99 0.89 0.79 0.69 S2008,2009 S increase D2009 (low-cals appear) D2008 50 100 150 200 250 The competitive market is self-balancing As Adam Smith wrote in Wealth of Nations, the competitive marketplace can regulate the use of resources for production, and which products and services are produced, with economic efficiency. Firms devote resources to products and services that are in demand. Pressure from competitors forces firms to be efficient.