Price Elasticity of Demand: Philip Morris

In 1993 Philip Morris cut cigarette prices by 18%. Its major competitor (RJ Reynolds) matched the price cut. Not surprisingly, the quantity sold of Philip Morris cigarettes increased (by 12.5%). In a June 13, 1994, article referring to the perils of a price cut, Fortune reported that Philip Morris profits fell by 25% as the result of a bad pricing strategy. Is there any evidence to determine whether this decision by Philip Morris managers decreased firm performance? Although all the information is not available, we are not surprised by this result. We estimate the price elasticity of demand for Philip Morris brands (including the iconic Marlboro Man) as revealed by the market.

Demand is inelastic, so any drop in price should surely decrease firm revenue. Total revenue decreased and total costs increased (because more cigarettes were produced), so profit was destined to fall.

Q: What do you think about this? The decline in total revenue from cigarette sales in 1993 is attributed to Philip Morris's cut in the price of cigarettes. Are there other factors that might have contributed to this decline in revenue? (explanation)