A strategy often employed by Walmart for example is to \"undercut\" it\'s compet

Question

A strategy often employed by Walmart for example is to "undercut" it's competition. In other words it will offer products "for sale" below it's Profit Margin in an effort to attract YOU the customer. Once you are there, they know that the Overall Sales (Revenue) for that day will increase as a result. So in the end, they turn a profit in OVERALL SALES (at the expense of losing a small amount on one product). Let's always be mindful of the equation for Revenue and Profit. (R=P*Q) Note that Price is only one half of that equation. Given the strategy just explained, note that Walmart's Pricing Strategy was in effort to increase the "Q" or Total Quantity Sold. In looking at Profit (Profit = R-C) note that given the above example the cost here was still below the TOTAL REVENUE they received by using this strategy. How might this strategy work in a Hospital for example (or perhaps in Health Insurance)?

Explanation / Answer

For this part, first note that the concept of elastcity becomes utmost important here. Elasticity of demand and supply curve is a measure of responsiveness of change in quantity demanded or supplied for a given change in the price. If the percentage change in the quantity is smaller than the percentage change in the price, the demand or supply is said to be inelastic.

Economic theory articulates that total revenue rises with fall in price if demand is elastic. It begins to falls as soon as the price elasticity becomes less than 1. Wal-Mart faces an elastic demand incomparison to health insurance market where patients cannot choose plans with the same degree of flexibility they can choose clothes or other product at Wal-Mart.

So when Wal-Mart lowers its prices, the sales revenue rises since the elasticity of its products is more than 1. For health insurance, the elasticity of demand is less than one and so the reveue will fall if prices are lowered.

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