5 Pricing Flashcards
In a perfectly competitive market, every buyer/seller is a:
Price taker and no participant influences the price of the product it buys or sell
What are some characteristics of a perfectly competitive market?
- 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.
What is imperfect competition?
To the market structure that does not meet the conditions of perfect competition.
What are some characteristics of imperfect competition?
- Monopoly - one seller of a good
- Oligopoly - few companies donate the market, and are inter-dependant
- Monopolistic competition - products are similar but not identical
What does price elasticity measure?
How responsive demand is to a change in price
How do you calculate price elasticity of demand?
Change in quantity % / change in price %
What does elastic mean?
Very responsive to changes in price.
What does inelastic demand mean?
Not very responsive to changes in price
What is the equation for total cost function?
y = a + bx a = fixed cost b = variable cost x = activity level
How do you calculate cost plus pricing?
Cost per unit + chosen margin or mark up
What is a mark up %?
A markup is the profit expressed as a percentage of cost (cost is 100%).
What is a margin %?
A margin is the profit expressed as a percentage of the sales price (sales is 100%).
What options are available for cost plus pricing?
Actual/standard
Marginal/full
Relevant costs
What are advantages of cost plus pricing? (5)
- 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.
What are disadvantages of cost plus pricing? (7)
- 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
What is customer based pricing?
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.
What is competition based pricing?
Setting a price based upon the prices of competing products
What is market skimming?
Charging high prices when product is first launched to maximise short term profitability
What are the conditions for market skimming?
- 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
What is penetration pricing?
Charging of low prices when a product is launched to gain rapid acceptance
What are the circumstances of penetration pricing?
- 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
What is complementary product pricing?
One usually used with another product
What is product line pricing?
Product line pricing occurs when setting the price steps between various products in a product line
What is volume discounting pricing?
Product line pricing occurs when setting the price steps between various products in a product line
