Chapter 7 - The pricing decision Flashcards
What is price elasticity of demand and how to calculate it?
Price elasticity of demand measures the change in demand as a result of change in price:
Change in demand as a percentage of demand / change in price as a percentage of price
What is elastic demand?
Price elasticity > 1
Demand very responsive to changes in price
Rev increase when price reduced
Rev decrease when price increased
Price cuts recommened.
What is inelastic demand?
Price elasticty < 1
Demand not very responsive to price change
Rev decrease when price reduces
Rev increase when price increases
Price increases recommened.
What is price stickiness?
Occurs when competitors tend to follow price cust with cuts of their own and do not copy price rises.
Which factors can influence price elasticity?
- Scope (larger market, more inelastic demand);
- Information within market
- availability of substitutes (less differentiation, greater price elasticity);
- complementary products (interdepency leads to inelastic (e.g. batteries);
- disposable income (may vary, luxe goods high price elasticty, necessities inelastic;
- Necessitities: inelastic
- Habit items: inelastic
Describe the perfect and imperfect market
Perfect
- every buyer/seller is price taker;
- zero entry/exit barriers;
- perfect information;
- aim to maximise profit;
- homogeneous products
Imperfect
- only one seller of a good (monopoly)
- few companies selling goods (oligopoly)
- Monopolistic competition: similar products but not identifcal (e.g. brands of soap).
What is the profit maximisation model? and it’s formula.
Profit is maximised at the output level where marginal cost is equal to marginal revenue
MR = MC
Price equation: P = A + BQ
How to calculate the marginal revenue?
MR = A + 2 BQ
What is the procedure to establish the optimum price of a product?
1) establish linear relationship between price and quantity demanded (p = a+bq)
2) Find marginal revenue (MR = a + 2bq)
3) establish marginal cost
4) Equate MC = MR (solve with finding q)
5) Find optimum price
6) May be necessary to calc max profit.
What are the limitations of the price maximisation model?
Limited practical use because:
- Unable to determine demand function of the product;
- Aim is often target profit not maximum;
- Difficult to get accurate/reliable marginal/variable cost;
- Ignores variety due to volume (e.g. bulk discounts);
- Ignores other factors like advertisement, changes income of customers etc…
What is total cost plus pricing (pricing strategy)?
Add mark up to total cost of the product. Reliant on units produced/sold.
What are plusses and minusses of the total cost plus strategy?
Plus:
- Required profit is made when budgetted sales volume is made;
- Useful in few large contracts business where fixed costs are low vs variable costs;
- quick/cheap to employ;
- helps justify prices to customers;
Problems:
- Difficult to find suitable bases/selling prices show variation;
- Reliable on meeting volume target;
- Ignores other factors like competition;
- Ignores price customers are willing to pay in different stages of lifecycle.
What are the advantages and disadvantages of the marginal cost-plus pricing?
- Just as accurate as total cost plus
- Option to price below total cost (to fill capacity)
- Useful in pricing specific one-off contracts
- Recognises the existence of scarce or limititing resource. Aim to maximise contribution of limiting factor
Main disadvantage, it can create a race to the bottom.
Pricing strategy: what is premium pricing?
pricing above competition on a permanent basis
done in case where product/service is different and or superior to competition in terms of quality, image, reliability, durability, after sales service or extended warranties.
Pricing strategy: what is market skimming?
high price initially, than lower.
maximise revenue (where MR = 0)
books, wedgwood, must be significant entry into market.
