Pricing Flashcards
The objectives of firms are likely to include: (3)
- Profits
- Growth
- Increase in market share
Are firms price-takers?
Auction - art, electricity, some financial assets. - buyer sets the price
Commodities - uniform goods, often sold on exchanges, ‘anonymous’
bids and offers. - buyer sets the price
Retail - products might be available from multiple vendors, but a vendor would typically not engage in haggling. - firm sets the price
Business-to-business - price and quantity might be negotiated, could be a single purchase or repeat business.
Cost-plus’ pricing
Full cost pricing
The firm could set m (the ‘mark-up’ or ‘costing margin’) to some
desired level and then set
P = (1 + m)UC
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When is the firm setting prices?
However, to know for certain the full costs of producing a unit the
firm would perhaps have had to have already produced the unit and have complete accounting information.
When is the firm setting prices?
However, to know for certain the full costs of producing a unit the
firm would perhaps have had to have already produced the unit and have complete accounting information.
If a firm is setting the price for something which it is currently
producing or has not yet produced then it might not be certain of the costs of material inputs, the total amount of output to be produced, the exact amount of labour to produce each unit, overhead costs etc.
Normal cost pricing
Given the intended utilization rate of Normal productive capacity and
the expected costs the firm can calculate ‘Normal unit costs’ (i.e. the unit cost if everything turns out as expected) and use this as the basis for pricing:
P = (1 + m)NUC
Target rate of return pricing
m could depend on different things - the firm might set a low value if it is trying to increase sales a lot, or perhaps a higher value if it is trying to increase profits and has a ‘captive’ market.
One possible basis on which to set the value of m would be to plan
to achieve a target return on assets, e.g. at a conventional level of 15% or similar.
What about demand?
The price which a firm sets is not constrained by demand, but the
outcome will depend on demand. If a firm sets a price which no-one
is willing to pay then it will have zero sales and go out of business.
Supposing that a firm has set a price at which it has some sales and some profits, does it then adjust the price frequently as demand varies (why does demand vary?).
Expectations: People will buy more of something if they suspect the value of it will increase in the future.
Income: The amount of income earned by consumers will determine demand.
Price: Demand and price have an inverse relationship.
Availability of alternatives: Substitute products are products that are closely related.
Responsiveness of prices to variations in demand
In the short-term, prices tend not to change, for several reasons:
- Goodwill
- Costs of deciding new prices
- Costs of changing prices
- Uncertainty about the permanence of a variation in demand
What About Competitors?
We thought that consumer choices are largely independent (except
perhaps for social effects).
For firms, there will often be direct competition, with the objectives
of one firm being incompatible with another firm in the same market.
Strategic interaction and market structure are the following topics.
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