Profits are Extremely Pro-cyclical.

At the early stages of recovery, inventories go down, with sales surpassing production and injecting new liquidity to the business. The following increase in production is obtained by a higher production utilization of plants and employment. Productivity steeply rise and profits as well.

During recovery and boom, employment and capital accumulation (investments) can go hand in hand, increasing absolute profits if not profitability.

At the end of the boom phase, high interest rates on loans (taken for funding investment and discretionary costs) hurt profits, as well as higher wages can do.

Often unexpected, the demand downturn make inventories piling up, freezing resources and forcing a fall in production. Before this adjustment takes place, profits plunge even into negative values.

Profits From Product Innovation

Consider a market with product differentiation, as this. An R&D investment over the years leads to an improvement of one product features and the management decides to substitute this new model to the existing one. Let's imagine for simplicity's sake that costs of product are the same as the previous version.

Three main effects will increase sales:

1. consumers who did not buy the good because it did not satisfied their minimum requirements on this feature can now buy, to the extend the improvement is sufficient at their eyes;

2. consumers who decides by a "top-quality" rule and positively value the feature could switch from their current provider, to the extend the overall quality of the new good becomes superior;

3. consumers who decides by a "value-for-money" rule could switch from their current provider, to the extend the price / quality relationships of the new good becomes more convenient.

At the same time, the price of this new version could be set higher than before, so that sales would be braken, unit profits boosted. Overall profits would soar.

Try all this - and the consequences of competitors' reaction - by playing this business game.