Question

1. Explain how the use of different levels of discount rates make trade-offs between current and future welfare. Give me one example of a situation in which a higher discount rate would be appropriate and one example of when a lower rate would be appropriate.

Answer 1

Trade Off and Explanation:-

Discounts are a way in which companies look to increase sales in volumes. They reduce the prices of the final goods being sold in the market which usually pushes the demand of the commodity upwards.

Across the globe, companies use this strategy for various reasons ranging from seasonal demand patterns to others such as market penetration.

However, whenever a company engages in providing discounts it has a tradeoff to deal with. Excessive discounts are often seen negatively by the consumers they believe that the value of the goods being sold and the brand as a whole is relatively lower. This may effect the sales in the long run in which companies become unable to sell their product due to damage to a brands value in the eyes of the customer.

On the other hand they have to look at short term benefits of offering a discount also which includes increased sales and volumes when the prices are pushed downwards.

Here, trade off refers to the implication of offering a discount in the short and long run. A company looks at short run profits and will also have to analyze the impact on its brand value and devise an optimum discount and length at which the same is to be offered.

Examples:-

1) When Would a firm offer a higher discount rate:-

A higher discount rate can be provided by a firm when it is not well established as yet in the market. It is useful for small companies which have just started selling the product as it allows them to penetrate the market easily. Once established these discounts can be easily erased by adding costs to the existing consumers.

A prime example of this are new network providers who offer attractive discounts when the enter the market and gradually increase prices to remain competitive.

2) When would a firm offer a lower discount rate:-

A well established firm with a constant market demand is more likely to offer a lower discount rate in comparison to smaller companies as indicated above. This is because companies which are well settled can earn sufficient profits without dipping the prices significantly.

For example a company like Apple lowers the product price only during seasonal spike such as New Years and the discount often is very tiny. Yet due to the market demand and brand value which it has it can increase sales substantially.

Please feel free to ask your doubts in the comments section if any.