Tag: Apple price increases

Supports: Microeconomics and Economics, Chapter 6, Section 6.3, and Essentials of Economics, Chapter 7, Section 7.7.

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An article in the Wall Street Journal on June 25, noted that after Apple increased the prices of iPads and MacBooks, the price of its stock declined by 6.1 percent. That decline meant that the total value of Apple’s stock—its market cap—fell by $215 billion dollars that day. Investors were expecting that Apple would likely also increase the prices of iPhones. As we discuss in Microeconomics, Chapter 8 (Macroeconomics and Essentials of Economics, Chapter 6), the price of a firm’s stock reflects investors forecasts of the future profitability of the firm. Why would Apple increasing the prices of its products cause investors to believe that Apple’s profit would decline? Shouldn’t Apple become more profitable after increasing its prices?

Solving the Problem
Step 1: Review the chapter material. This problem is about the effect on a firm’s profit of increasing the price of its product, so you may want to review Chapter 6, Section 6.3, “The Relationship between Price Elasticity of Demand and Total Revenue.”

Step 2: Answer the question by explaining under what circumstances a firm may reduce its profit by raising prices.  It might make sense to think that any time a firm raises its price, it will increase its profit. But recall that because demand curves slope downward, an increase in price always results in a decrease in the quantity of the good sold. If the firm’s demand curve is elastic at the current price level, raising the price will decrease the firm’s revenue because the quantity sold will fall by proportionally more than the price increases. In this case, investors appear to have assumed that the revenue Apple would lose as a result of raising prices would be greater than the additional revenue it would earn on the quantities it would sell at the higher prices. Revenue isn’t the same as profit because Apple’s total cost will decrease as it sells a smaller quantity. Because the price of Apple’s stock declined substantially on the day the firm announced the price increases, investors must be expecting that the net effect of the price increases would be to reduce Apple’s profit.