Discuss the policies that businesses might adopt to maintain sales when incomes are falling and consider which is most likely to be successful.  One potential strategy adopted by a firm in a time of high inflation or recession, both of which would cause a fall in real incomes, in order to maintain sales revenue could be a decrease in the price of the product.
This would be because a fall in income levels would cause all product to cost a higher proportion of the consumers’ incomes, thus becoming more significant purchases and, in turn, leading to a higher price elasticity of demand. As such, if, as the demand becomes more elastic, the value for its PED becomes higher than 1, the firm could serve to increase its sales revenue through a price decreases.
This is because, due to the nature of the PED as a measure of the responsiveness of the quantity demanded in relation to changes in the price of a product, calculated through a division of the percentage change in the quantity demanded in relation to the percentage in the price of the product, if its value exceeds 1, then the increase in the quantity demanded wold be disproportionately higher than the fall in the price of the product, thus causing an increase in total revenue.
Thus, through decreasing the price of their product in a period of falling real incomes, a firm could help maintain the same, or even higher levels of sales revenue. This policy is by no means perfect however, while a drop in the price may be highly effective at increasing revenues, this would only be the case if the fall in incomes manages to drive the price elasticity of demand high enough that it would exceed 1.
Moreover, as the firm lowers the price of its good, it will likely lower the price elasticity of demand as well, thus such a policy can only be implemented to increase revenues until the price elasticity of demand reaches 1, at which point the firm will have to adopt other strategies to increase revenue. Another likely strategy adopted by a firm could be a switch in the nature of the good produced. During a period falling real incomes, the firm would likely begin producing more inferior goods and fewer normal goods.
This is because inferior goods have a negative value for their YED, thus as income falls, the demand for inferior goods rises. Thus, through an increase in demand for inferior goods, the firm could serve to increase its sales revenue by taking advantage of the shortage of such goods that is likely to arise in the short term and the subsequent increase in the price of inferior goods as the market reaches a new equilibrium. While such a policy is almost certain to help maintain, or even increase, sales revenue, it may not always be feasible to implement such a shift in production.
If the firms price elasticity of supply is too low, either because of long production times, low occupational mobility of the factors of production used, or high sunk costs in the industry, the firm will likely find it nigh on impossible to switch production to that of an inferior goods, thus highly limiting the potential effectiveness of such a policy. As such, in the cases where the firm would struggle to lower the price or change the nature of the good they are producing, a possible third policy can be implemented.
The firm can attempt to use marketing techniques such as increased spending on advertising in order to increase demand and lower the price elasticity of demand. This advertising would increase information to the consumer about the product, thus increasing the price elasticity of demand for competing products, while decreasing it for the firm’s own product; it would also increase the cross elasticity of demand for the product in relation to substitutes. Moreover, the increased information is likely to also cause a flat increase in the quantity demanded at every level of price.
At this point, the firm can then proceed to adopt a plethora of subsequent pricing strategies in order to maximise sales revenue. It can take advantage of the now lower PED and higher level of demand in order to increase revenue through an increase in the price of the product. Alternatively, it could exploit the now higher XED and lower the price of their goods in order to attract more customers from competing substitutes in order to help increase the demand for their own product and as such increase their sales revenue.
Moreover, if the fall in incomes is due to a recession, the firm could take advantage of the fact that most other businesses will attempt to cut costs in order to get a higher Share of the Voice for the same cost, thus further increasing the effectiveness of the advertising. Despite these advantages, similarly to a change in the nature of the production, such an endeavour might be too costly for the firm to implement, with the opportunity cost being so high that the firm might instead invest funds into other projects.
This would be particularly true in the case of a recession, where the firm might be forced to cut costs in order to maintain an adequate level of profitability and cash flow. Moreover, the firm might be selling products which do not need advertising, such as necessity goods (i. e salt, housing, basic food items) which most people will already know about and purchase on a regular basis regardless of advertising thus making such spending wasteful and unimpactful.
Overall, I believe that the change in the nature of the good produced to an inferior good is by far the most likely method to be successful in maintain revenue, due to the fact that, by their very nature, inferior goods experience an increase in demand when incomes fall, thus allowing the firm to have an increase in sales volumes and, in turn, an increase in sales revenue. If the firm can afford to implement this, a change in the nature of the product to an inferior good will raise revenues in almost all scenarios where incomes are falling.