9. Pricing Flashcards
What are the two main considerations for setting prices?
A price the customer will pay that is also profitable for the long term
What are the 3 main pricing strategies?
- Market driven optimum pricing
- Cost based approaches
- Specific strategies - e.g skimming, penetration pricing
What is a market in perfect competition?
A business can sell as many items as it wishes at the prevailing market price but cannot influence the price
What is a market in imperfect competition?
In order to sell more items, the price has to be lowered
What are the 3 steps of the mathematical approach to finding the profit maximizing position on a downward sloping demand function?
- Identify the equation for the price demand relationship
- Identify the marginal revenue and marginal cost functions
- Solve for MR = MC to find the price/quantity mix that maximizes profit
What is the exact point in terms of MR and MC at which profit is maximised?
Where Marginal Revenue = Marginal Cost
What is the equation for the price demand line?
P = a - bX
What is the equation for marginal revenue at a set quantity?
MR = a - 2bX
If you are trying to maximise revenue rather than profit, what point do we need to operate at in terms of marginal revenue?
MR = a - 2bX = ZERO
What is the equation for price elasticity of demand?
% Change in Qty / % Change in Price
What does it mean if PED is > 1?
Demand is elastic, price sensitive - a change in price leads to a bigger change in quantity, a drop in price will increase revenue
What does it mean if PED is < 1?
Demand is inelastic, price insensitive - a change in price leads to a smaller change in quantity, a rise in price will increase revenue
What 3 things impact price sensitivity?
- Number of competitors and similarity of their products
- How much of a consumers disposable income it takes up
- Product considered luxury or necessity
What is the main reason for using marginal cost for pricing?
Useful as a minimum price where there is SPARE capacity
What is the main issue with marginal costing?
Ignores fixed costs which need to be covered in the long term
What is the main reason for using relevant cost in pricing?
Includes opportunity costs and so is good to set minimum price where there are scarce resources
What are the 2 main benefits of absorption/ABC costing in pricing situations?
- Guarantee all costs are covered in the short and long term, as long as budgeted demand is achieved
- Quick and cheap method of setting prices
What is the 2 main issues with absorption costing?
- Need to ensure consumers are happy paying the price
2. Need OAR method to be fair
What are the 2 main benefits of standard costing in pricing situations?
- Allows a set selling price that is kept stable
2. Any internal inefficiency is borne by the business rather than the customer
What 4 reasons might a business have to adapt their pricing policy for?
- Stage of product lifecycle
- Entry of competitors
- Different geographical demands
- Changes in technology
What is market skimming?
Initially charging high prices to cover upfront costs, then lowering as prices become mature
When is market skimming commonly used?
High tech products, that get updated quickly, that are perceived as desirable and unique
What is premium pricing?
Products marketed as higher quality to support a permanent high price strategy, with high quality support services
What is penetration pricing?
Low initial price set to gain high volumes and market share, creating a barrier to entry for other possible entrants
