Who’s the most hated man in America? Well, if you’ve glanced at social media over the past day or two, the resounding answer seems to be Martin Shkreli.

Shkreli is CEO of Turing Pharmaceuticals, a US firm that acquired rights to Daraprim—a drug that treats toxoplasmosis, a parasitic affliction of many AIDS patients—back in August. Since then, the company has decided to raise the price of Daraprim from $13.50 per dose to $750.00 per dose—a price increase of over 5,000 percent! The pill costs about $1.00 to produce.

This 62-year-old drug just got 5,000% more expensive http://t.co/YVlHDRNAlu pic.twitter.com/pxbF1zWqHt

— Fortune (@FortuneMagazine) September 22, 2015

A former hedge fund manager, Shkreli originally defended his firm’s decision on the basis of profit considerations. So, is Martin Shkreli an evil guy, attempting to make a profit off of sick people that need his product? Maybe. But it’s more likely he just let monopoly power go to his head…

The backlash against the firm brings the idea of monopoly pricing out into the open. The decision of where to price a product is one of the toughest that a firm has to make. For a pharmaceutical company with complete pricing power over its product, it’s usually even more challenging. Aside from the production cost of pills, a drug company must also think about numerous other factors, such as pricing to recover the costs of research and development (R&D), patient willingness to pay, whether government insurance will pay a higher price, and others.

However, one factor that all companies must consider when deciding on a price is equity—is this a fair price to charge for a product that people need? Where Shkreli got it wrong is in severely underestimating fairness considerations when deciding where to price. And because he only focused on profits, he’s paying for it.

Here's why Turing Pharmaceuticals says 5,000% price bump is necessary http://t.co/RAhefQlvKH

— Fortune (@FortuneMagazine) September 23, 2015

Read more about the controversy:

• US pharmaceutical company defends 5,000% price increase via the BBC
• CEO: 5,000-percent drug price hike "not excessive at all" via CBS News
• A pharma CEO tried to defend his decision to jack up the price of a critical drug by 5,000% - and it backfired via Business Insider
• Jump in Price for an Old Drug Will Be Rolled Back, C.E.O. Shkreli Says via the New York Times
• US drug company to cut 5,000% price rise after backlash via The BBC

There’s an old, near-funny joke about economists that goes something like this:

A physicist, a chemist and an economist are stranded on a desert island, with no food to eat. A can of soup washes ashore, but it’s sealed. So each professional ponders how to get it open…

“I’ve got it. Let’s smash the can open with a rock,” exclaims the physicist.

“No, no. The soup will splatter that way,” says the chemist. “Let’s build a fire and heat the can first.”

“You’re both wrong,” retorts the economist. “Let’s assume we have a can opener….”

The joke is corny at best. It may have even gone over your head. My apologies.

But the stereotypes in the joke are spot on, especially for the economist. One of the biggest gripes that people have with economists (and economics as a whole) is that the models that they build to represent the world often require unrealistic or even impossible assumptions in order to get results. What’s the point of building models that do not accurately represent reality?

One of the most cited examples of wishful thinking in economics is the model of perfect competition. Those of you that took Econ 101 in undergrad are (or at some point were) probably familiar with this idealist representation of how economic markets distribute goods and services. In short, perfect competition is a market condition in which no market participants (buyers, sellers, etc.) are powerful enough to set the price of a homogenous good or service.

Economists expect markets to be perfectly competitive when the following conditions hold:

1. Products are identical: sellers offer the exact same product and buyers are equally willing to buy from any seller.
2. Many small price-taking participants: there are numerous buyers and sellers, none of which has the ability to influence the market price substantially, and no single firm or consumer accounts for a large portion of production or purchases.
3. Perfect information: Buyers and sellers are fully informed about the quality of products and prices available in the market.
4. Identical sellers: suppliers have full access to the same inputs and production technologies as one another.
5. Free entry and exit: many new firms can enter the market on the very same terms as existing ones if the market is profitable and, similarly, firms can exit the industry without incurring extra costs.

Can you think of a market that satisfies these conditions? I certainly can’t… I myself used to be baffled at how strict its assumptions were. Models are supposed to be an accurate representation of reality, and this one certainly is not.

Conditions 1-3 above generate the equilibrium of a theoretical market. Firms will earn a profit at the market equilibrium if the market-clearing price is greater than the firms’ average total cost. But the presence of profits will entice more firms to enter, driving up production and pushing down prices until such competition and entry completely destroy profits. Products, prices, firms and consumers are all the same, so no one company can do anything about it. Perfect competition prevails leaving no profit.

Conditions 4-5 eliminate many of the market frictions experienced by real-world companies trying to enter or exit an industry. With all firms equally efficient and free to come and go as they please, competition is as intense as one can imagine. Since firms can leave, so no businesses make losses but none make money either. They simply break even. In this environment, one starts to question what’s so “perfect” about this form of competition. From a manager’s point of view, it’s hard to think of anything so far from ideal…

But when you look at it that way, I hope a lightbulb goes off for you. True, perfect competition is not a very useful model with which to classify modern industries today. But it’s a darn good one for a strategist to measure his or her firm against to see why and how their profit-making enterprises differ. To be clear, perfect competition is significant not because it is common (there are few to none of such markets in real life). Its real importance lies in the observation that departures from perfect competition are what underlie high profits and firms’ competitive advantages.

And for each departure from one of the model’s condition, firms have a chance to exploit attractive profit opportunities:

1. Differentiated Products: in actuality, not all products are exactly the same, and thus some firms have the power to charge premiums for better quality or target different customer segments. A firm’s ability to create value for a customer through a differentiated product or service yields profits for the firm by being able to charge a higher price.
2. Few, Price-Making Participants: actual markets are often dominated by a handful of powerful buyers or sellers that have substantial market power to move prices (the most extreme case being a monopoly who is the sole seller to a large number of buyers).
3. Imperfect Information: in the real world, market information is far from readily available and buyers must spend time searching out reliable information. Buyers are often short on time and make decisions using cognitive shortcuts, not taking all information into account. So firms that can create customer loyalty will benefit greatly.
4. Unique Sellers: some firms will ultimately have unequal access to production technologies and different input costs, making their overall costs structures very different. Firms with superior access to technology and cheap supplies can generate high profits even when the marginal firm earns no profits.
5. Barriers to Entry and Exit: in reality, incumbent firms have certain advantages, such as prior experience, lower production costs, and others, that entrants cannot easily mimic, which discourages free entry into the industry. Similarly, exit costs may be substantially high, forcing loss-making firms to stay in the industry.

The sources of advantage above are by no means the only ones available to a firm, but encapsulate useful forces to think about when planning your firm’s strategy. Use them wisely and your firm will profit.

As I’ve argued before, economics is far from perfect and at times a bit idealistic. Models, like the theory of perfect competition, do not depict the state of affairs particularly well. Nonetheless, it’s sometimes the holes in economists’ models that provide the food for thought that can lead to a lasting business strategy or new innovation that changes an industry.

Price goes up, and demand goes down. It’s one of the most fundamental relationships in economics. If the price of a cup of coffee increases, demand for coffee, all else equal, will fall. For example, if your regular Starbucks drink order were to double in price overnight, you might reconsider indulging in your daily fix of caffeine.

But does this inverse relationship between price and quantity demanded always hold? No - and for many reasons.

Anyone who has taken Econ 101 can cite some famous exceptions to the so-called “law” of a downward-sloping demand curve. For example, demand for a luxury good, like a sports car, might actually be greater with a higher price. For some car buffs, a high price may be a signal of superior quality, and more Lamborghinis would be demanded the steeper the price tag.

On the flipside, demand for some other goods (so-called “Giffen” goods, named after Scottish economist Robert Giffen), may fall with price. When the price of a cheap commodity, such as rice, falls, the average shopper might feel just a little bit wealthier and buy the quinoa this week instead.

So that's how it works with consumer goods - but what about services? That's a trickier question and yet an even more important one to answer.

As workers throughout many cities in the U.S. and Europe continue to demand a higher minimum wage (many protestors in America are looking to double the $7.50 base wage), the question of whether the law of demand applies to labor markets is becoming increasingly important to politicians, policymakers, and businesses.

A business perspective

How can we think about this issue of higher wages from the point of view of a firm, or a manager? And what conclusions can we draw for our business?

Let’s first look at it from a purely economic perspective: In theory, a hike of the federally-required minimum wage should depress the demand for labor. If companies must pay each worker more, the law of demand predicts that they will hire fewer workers. The minimum wage sets a floor under which businesses and potential employees cannot contract, even if both sides are willing. Based on price alone, the number of jobs available to all in the labor force should theoretically fall.

If that's the case, nationwide cries for better compensation for minimum wage earners would then only benefit those employees who still have jobs after the policy change. Less-skilled workers, whose hourly output may be valued by companies at less than $15, might be laid off, and those who are already out of work may find it even harder to get a job.

Businesses are getting steamrolled on the minimum wage. Here’s why. http://t.co/pMIR2MIM67

— Washington Post (@washingtonpost) July 25, 2015

What’s more, as technology becomes more sophisticated, it becomes increasingly more attractive for firms to switch from humans to labor substitutes such as robots, drones, and self-service machines. A construction worker or maid, whose skills are hard to imitate, may still be able to find a job at a higher minimum wage. A permanently pricier cashier or secretary with little experience might not. Increasing the costs of workers would very likely expedite the process of automation (which is already moving forward at a staggering pace).

Fewer people working and greater incentives to invest in job-stealing cyborgs... economically at least, it appears to be an inappropriate moment to be raising the price of workers.

Is it that simple?

However, as we saw in the case of goods, economics is often far from cut and dry. True, an increase in the price of labor may decrease firms’ demand for workers—but again, we must add that pesky “ceteris paribus” or “all else equal” clause to the end of any conclusion we can draw. That is, a minimum wage boost would decrease the demand for workers, assuming the policy change affects nothing else. Yet this is not often the case; other variables may matter. And these variables may matter a lot for your business.

For example, maybe an increase in wages would boost employee morale and actually increase productivity, creating more value for your company. Or maybe better-paid employees value their jobs more, and staff turnover is reduced because of the change. Any number of factors could play a role and, indeed, managers must take into account more than just the cost of a worker before deciding to hire or fire.

VIDEO: Seattle restaurant that raised minimum wage to $15 ahead of schedule reports success: http://t.co/zDCFFauNLG

— The Associated Press (@AP) July 31, 2015

The law of demand, and more generally the field of economics, is often far more nebulous than textbooks make it out to be. Will an increase in wages be beneficial to the cities and countries that are considering such a measure? It's hard to tell. But, for managers and policymakers, a basic understanding of economics can provide a useful framework for making decisions and understanding the possible impacts of such a change. 

What do you think will happen?