5 Pricing

Question 1

In a perfectly competitive market, every buyer/seller is a:

Answer 1

Price taker and no participant influences the price of the product it buys or sell

Question 2

What are some characteristics of a perfectly competitive market?

Answer 2

• Zero entry/Exit barriers–It is relatively easy to enter or exit as a business in a perfectly competitive market.
• Perfect Information–Prices and quality of products are assumed to be known to all consumers and producers.
• Companies aim to maximise profits–Firms aim to sell where marginal costs meet marginal revenue, where they generate the most profit.
• Homogeneous products–The characteristics of any given market good or service do not vary across supplier.

Question 3

What is imperfect competition?

Answer 3

To the market structure that does not meet the conditions of perfect competition.

Question 4

What are some characteristics of imperfect competition?

Answer 4

• Monopoly - one seller of a good
• Oligopoly - few companies donate the market, and are inter-dependant
• Monopolistic competition - products are similar but not identical

Question 5

What does price elasticity measure?

Answer 5

How responsive demand is to a change in price

Question 6

How do you calculate price elasticity of demand?

Answer 6

Change in quantity % / change in price %

Question 7

What does elastic mean?

Answer 7

Very responsive to changes in price.

Question 8

What does inelastic demand mean?

Answer 8

Not very responsive to changes in price

Question 9

What is the equation for total cost function?

Answer 9

y = a + bx 
a = fixed cost
b = variable cost
x = activity level

Question 10

How do you calculate cost plus pricing?

Answer 10

Cost per unit + chosen margin or mark up

Question 11

What is a mark up %?

Answer 11

A markup is the profit expressed as a percentage of cost (cost is 100%).

Question 12

What is a margin %?

Answer 12

A margin is the profit expressed as a percentage of the sales price (sales is 100%).

Question 13

What options are available for cost plus pricing?

Answer 13

Actual/standard
Marginal/full
Relevant costs

Question 14

What are advantages of cost plus pricing? (5)

Answer 14

• Widely used and accepted.
• Simple to calculate if costs are known.
• Selling price decision may be delegated to junior management.
• Justification for price increases.
• May encourage price stability –if all competitors have similar cost structures and use similar markup.

Question 15

What are disadvantages of cost plus pricing? (7)

Answer 15

• Ignores economic relationship between price and demand
• No attempt to establish optimum price
• Different absorption methods give rise to different costs
• Does not guarantee profit
• This structured method fails to recognise the manager’s need for flexibility in pricing
• Circular reasoning

Question 16

What is customer based pricing?

Answer 16

Customer based pricing reflects customers’perceptions of the benefits they will enjoy from purchasing the product, e.g. convenience, status. The product is priced to reflect these benefits.

Question 17

What is competition based pricing?

Answer 17

Setting a price based upon the prices of competing products

Question 18

What is market skimming?

Answer 18

Charging high prices when product is first launched to maximise short term profitability

Question 19

What are the conditions for market skimming?

Answer 19

• Product is new and different and has little competition
• Short life cycle
• Where the strength of demand is unknown
• Firm with liquidity problems may use this to generate cash flow

Question 20

What is penetration pricing?

Answer 20

Charging of low prices when a product is launched to gain rapid acceptance

Question 21

What are the circumstances of penetration pricing?

Answer 21

• Increase market share
• Wishes to discourage new entrants into the market
• Significant economies of scale to be achieved
• If demand is highly elastic and would respond to low prices

Question 22

What is complementary product pricing?

Answer 22

One usually used with another product

Question 23

What is product line pricing?

Answer 23

Product line pricing occurs when setting the price steps between various products in a product line

Question 24

What is volume discounting pricing?

Answer 24

Product line pricing occurs when setting the price steps between various products in a product line

Question 25

What are benefits of using a volume discounting strategy?

Answer 25

• increased customer loyalty
• attracting new customers
• Lower sales processing costs
• Lower purchasing costs
• Discounts help to sell items brought on price
• Clearance of surplus stock

Question 26

What are the conditions for volume-discounting?

Answer 26

• Sales margin is substantial allowing profits to be made
• The product is brought on price and is difficult to distinguish it from competing products
• Limited shelf life

Question 27

What is price discrimination pricing?

Answer 27

A pricediscrimination strategy is where a company sells the same product or services at different prices in different markets, for reasons not associated with costs

Question 28

What are the conditions for price discrimination?

Answer 28

1. Must have some degree of monopoly
2. Customers can be segregated
3. Customers cannot buy and sell in different markets
4. Effective for services
5. There must be different price elasticities of demand in each market so that prices can be raised in one and lowered in the other to increase revenue

Question 29

What are the dangers of price discrimination?

Answer 29

• A black market may develop allowing those in a lower priced segment to resell to those in a higher priced segment.
• Competitors join the market and undercut the firm’s prices.
• Customers in the higher priced brackets look for alternatives and demand becomes more elastic over time