P2C.3 Pricing

Question 1

Cost Based Method

Answer 1

1. Cost driven

2. Focuses on product and costs

Question 2

Basic Cost Based Approach Formula

Answer 2

Price = (Total fixed costs + total variable costs + desired profit) / Number of units produced

Question 3

Cost Plus Markup Approach Formula

Answer 3

Price = Cost * (1 + markup percentage)

Question 4

Market Based Method

Answer 4

1. Competition driven

2. Focuses on consumer and the customer perceived value

Question 5

Value Engineering

Answer 5

1. Process of identifying and evaluating costs in value chain
2. Goal is to reduce non-value added cost of a product to the level of acceptable (target) cost

Question 6

Value Added Activity & Cost

Answer 6

Activity: activity that customers perceive increased quality, utility or value to a product of service

Cost: cost incurred to perform the value adding activity.

Question 7

Market Penetration Pricing

Answer 7

Setting a low price to penetrate or introduce a product into a buyers market

Question 8

Market Skimming Pricing

Answer 8

Setting a higher price to penetrate or introduce a product to a sellers market

Question 9

Predatory Pricing

Answer 9

Setting the price at a very low price to control the market or discourage competition

Question 10

Product Bundling Pricing

Answer 10

Packaging interrelated products at a reasonably low “all-in-on” price

Question 11

Off Peak Pricing

Answer 11

Pricing the product at a lower price during periods of low sales or low season to attract customers

Question 12

Peak Load Pricing

Answer 12

Pricing high when operating at full capacity and pricing low when operating with excess capacity

Question 13

Price Discrimination

Answer 13

Pricing that only applies to certain segment of people.

Ex: providing % off price for students.

Question 14

Pure Competition

Answer 14

Product: homogenous or identical
Ex: poultry or farm products
Competition: large number or sellers
Pricing: price takers

Marginal cost curve = supply curve
Individual firm’s demand curve is perfectly elastic.

Question 15

Monopolistic Competition

Answer 15

Product: similar but not identical (differentiated)
Ex: toiletry products or beverages
Competition: several sellers
Pricing: limited control

1. Entry is relatively easy with only a few obstacles.
2. Monopolistic competition is characterized by interdependent firms, some (but not total) control over price, and heterogeneous products. Because products are heterogeneous, they are close but not perfect substitutes.

Question 16

Monopoly

Answer 16

Product: unique
Ex: electricity, paid government services
Competition: single seller, no competition
Pricing: price makers

Will maximize profits if it produces an output where marginal costs is equal to marginal revenue.
Downward-sloping marginal cost curve.

Question 17

Oligopoly

Answer 17

Product: standardized products
Ex: petroleum, telecom
Competition: few but large sellers. High degree of interdependence among firms. (High concentration ratio)
Pricing: competitor dependent / agreed upon cartel

Requires huge capital and technology requirements to enter.

Kinked demand curve: when an oligopolist lowers its price, the other firms in the oligopoly will match the price reduction, but if the oligopolist raises its price, the other firms will ignore the price change.

Question 18

Cartel

Answer 18

1. An agreement between competitors to set a fixed price on a good or service.
2. Only legal with government intervention.

Question 19

Target Cost per Unit

Answer 19

Difference between target price and target profit is allowable cost

Question 20

Target Cost per Unit Formula

Answer 20

= Target price per unit - target profit per unit

= (1 - profit target rate) * Total sales in dollars / Number of units sold

Question 21

Target Pricing

Answer 21

1. Pricing strategy used to create competitive advantage.
2. Target pricing involves selecting a price (the “target” price) for a product or service that will be very competitive in the market. Then, a process of “reverse engineering” is used to attempt to produce this product or service at a cost, lower than the target price, which will produce an acceptable profit margin.
3. Target pricing identifies a market-based price for a new or proposed product. This target price is then reduced by the desired profit margin to arrive at the product’s target cost.

Question 22

Price Elasticity of Demand

Answer 22

Measurement of how much changes in price will affect the supply demanded

Question 23

Price Elasticity of Demand Formula

Answer 23

(Q2 − Q1)
(Q2 + Q1)
(P2 − P1)
(P2 + P1)

1. Use absolute values
2. Q/Q & P/P, then Q/P

= 1, perfectly elasticity
= 0, perfectly inelastic
>1, greater elasticity

Question 24

Elastic Relationship to Demand & Price

Answer 24

Increase in price = Decrease in revenue
Decrease in price = Increase in revenue
Increase in demand = Increase in revenue
Decrease in demand = Decrease in revenue

Question 25

Inelastic Relationship to Demand & Price

Answer 25

Increase in price = Increase in revenue
Decrease in price = Decrease in revenue
Increase in demand = Decrease in revenue
Decrease in demand = Increase in revenue

Question 26

Coefficient of Elasticity

Answer 26

The coefficient of elasticity is multiplied by the change in price to determine the change in quantity demanded.

% change in quantity / % change in price