16. Marketing mix - price

Question 1

How do managers determine price?

Answer 1

• Cost of production: price must cover all of the costs producing it
• Competitive conditions in the market: if the firm is a monopolist, it is likely to have more freedom in price setting
• Competitor’s price
• Business and marketing objectives: profit maximisation or increasing sales
• Price elasticity of demand
• Whether the product is new or existing

Question 2

What are the pricing strategies?

Answer 2

• Price skimming
• Price penetration
• Competitive pricing
• Psychological pricing
• Cost plus pricing
• Price discrimination
• Predatory price

Question 3

Define cost-plus pricing

Answer 3

Adding an additional amount to the cost of the production means that profit per product is easier to work out

Question 4

Advantages of cost-plus pricing

Answer 4

• Easy, fast and common way to calculate

- Ensures that all your cost are covered

Question 5

Disadvantages of cost-plus pricing

Answer 5

• Does not take into account what the customers are willing to pay for the product -> reduced profit
• Does not look at what the competitor’s price

Question 6

Define competitive pricing

Answer 6

This is when the price reflects what the competition are doing and the product is priced competitively

Question 7

Advantages of competitive pricing

Answer 7

• Can change customer’s opinion on different companies

- Selling prices are in line with rivals => customers will consider other factors such as quality before purchasing it

Question 8

Disadvantages of competitive pricing

Answer 8

• Business have to attract the customers in other ways, since the price isn’t the only factor that grabs customers’ interest
• May only just production costs, resulting in low profits

Question 9

Define price skimming

Answer 9

A high price is used to enter the market and is skimmed off. This means that the business makes a lot of profit before competitors can enter the market. Often used by businesses dealing with technology

Question 10

Advantages of price skimming

Answer 10

• Help the company in covering R&D cost

- Very profitable if consumers care about quality rather than price

Question 11

Disadvantages of price skimming

Answer 11

• May slow down the volume growth of demand

- Can’t last long as competitors soon launch products with lower price

Question 12

Define price penetration

Answer 12

A low price is used to enter the market and build up customer loyalty. Once customer loyalty is earned, the price increases

Question 13

Advantages of price penetration

Answer 13

• Catching the competitor off guard
• Encourage word of mouth recommendation
• Force business to focus on minimising costs from the start
• Sales volume should be high -> distribution may be easier to obtain

Question 14

Disadvantages of price penetration

Answer 14

• Simply attract customers who are looking for a bargain rather than loyal customers
• Retaliation from established competitors

Question 15

Define psychological pricing

Answer 15

Setting a price that seems cheaper than it really is

Question 16

Advantages of psychological pricing

Answer 16

• Make the customer believe that the product is cheaper than it really is
• Allows the business to influence the way customer view the product without the need to change the product

Question 17

Disadvantages of psychological pricing

Answer 17

• Calculation complication and mistakes can be made

- Some people still take efforts to calculate prices carefully -> may not work on all individual

Question 18

Define price discrimination

Answer 18

Different prices are set for different customers or when a service is used at different times

Question 19

Advantages of price discrimination

Answer 19

• Able to increase revenue

- Making the products more affordable to everyone, some customers may benefit from lower price e.g. elders, babies

Question 20

Disadvantages of price discrimination

Answer 20

• Some has to pay higher => unfair
• Decline in consumers surplus
• Maybe administration cost increase because the company has to separate the markets

Question 21

Define predatory price

Answer 21

This is when the price is set deliberately low in order to drive competitors out of the market. This type of pricing may result in price war

Question 22

Advantages of predatory price

Answer 22

• Entry barrier: prevent new entrants to the market because the business will be able to dominate the market
• Drive competitors out of the market or drive weaker competitors into smaller niches within the market

Question 23

Disadvantages of predatory price

Answer 23

• May be illegal in some places
• Might make a loss due to the inability to cover costs
• Can work in the short term but may not be in the long term

Question 24

Define price elasticity of demand

Answer 24

• Measures the responsiveness of demand following a change in price
• percentage change in quantity demanded/ percentage change in price

Question 25

When is it price elastic?

Answer 25

• Beyond -1, e.g. -2, -3, -4
• A price change = a bigger change in quantity demanded
• %change in quantity is greater than % change in price

Question 26

When is it unitary price elastic?

Answer 26

• Numerical value: -1
• A price change = the same change in quantity demanded
• % change in Q is the same as % change in P

Question 27

When is it price inelastic?

Answer 27

• Between 0 and 1. e.g. -0.2, -0.3, -0.4
• A price change causes a smaller change in quantity demanded
• % change Q is smaller than % change in P

Question 28

What are the determinants of PED?

Answer 28

• Availability of substitutes - the more substitutes, the higher the PED
• How necessary the product is 0 the more necessary, the more inelastic
• Competition
• Level of consumer loyalty - inelastic
• The price of the product as a proportion of consumers’ incomes

Question 29

Applications of PED

Answer 29

• Making more accurate sales forecast
• Assist in pricing decisions
• Marketing - needs to know for planning purposes what may happen to its demand if it changes price
• Branding - businesses try to make the demand for their products more price inelastic through advertising and branding

Question 30

Limitations of PED

Answer 30

• PED assumes nothing else has changed. e.g. competition
• PED calculation becomes outdated quickly as businesses operate in a dynamic environment
• It is not always possible to calculate PED