Chapter 7 - Pricing

Question 1

Why is pricing important?

Answer 1

• it makes a pivotal contribution to profit maximisation
• the amount they are able to sell often determined by the price charged for the goods and services
• businesses make profits by selling goods at a price higher than their cost

Question 2

What are the 3 main factors that influence price?

Answer 2

• Customers
• Competition
• Cost

Question 3

What does a perfectly competitive market look like?

Answer 3

• Zero entry/ exit barriers
• perfect information
• companies aim to maximize profits
• homogeneous products

Question 4

What does an imperfect competitive market look like?

Answer 4

• Monopoly
• Oligopoly
• Monopolistic competition

Question 5

What is a zero entry/exit barriers market?

Answer 5

relatively easy to enter or exit as a business in a perfectly competitive market

Question 6

What perfect information in relation to a competitive market?

Answer 6

prices and quality of products are assumed to be known to all consumers and producers

Question 7

What is monopoly in a imperfect market?

Answer 7

• In which there is only one seller of a good.
• The seller dominates many buyers and can use its market power to set a profit-maximizing price

Question 8

What is oligopoly in a imperfect market?

Answer 8

• a few companies dominate the market and are inter-dependent: firms must take into account likely reactions of their rivals to any change in price, output or forms of non-price competition.

Question 9

What is monopolistic competition?

Answer 9

• products are similar, but not identical.
• many producers (‘price setters’) and many consumers in a given market, but no business has total control over the market price.

Question 10

What are the 2 broad approaches to pricing?

Answer 10

• Demand based
• Cost based
• marketing based

Question 11

Economic theory states that the monopolist maximizes profit when what?

Answer 11

Marginal cost = marginal revenue

Question 12

What is marginal revenue?

Answer 12

The additional revenue from selling one extra unit

Question 13

What is the marginal cost?

Answer 13

the cost of making one more unit. Usually the variable cost

Question 14

What is the calculation to establish the linear relationship between price (P) and quantity demanded (Q) in the algebraic approach? (1)

Answer 14

P=a - bQ

Question 15

What is ‘a’ in the algebraic approach?

Answer 15

the intercept - here the maximum theoretical price at which demand will fall to zero.

Question 16

What is ‘b’ in the algebraic approach?

Answer 16

• the gradient of the line - here the amount the price has to change to change the demand by one unit
• always negative

Question 17

How do we find the marginal revenue in the marginal revenue? (2)

Answer 17

Double the gradient to find the marginal revenue: MR = a -2bQ

Question 18

What is the third step in the algebraic approach?

Answer 18

Establish the marginal cost MC. simply the variable.

Question 19

How do we maximise the profit in the algebraic approach? (4)

Answer 19

equate MC and MR and solve to find Q

Question 20

How do we find the optimum price in the algebraic approach? (5)

Answer 20

substitute the value of Q into the price equation to find the optimum price

Question 21

How do we find ‘b’ in the algebraic approach?

Answer 21

Change in price/change in quantity

Question 22

What is the tabular approach?

Answer 22

involves different prices and volumes of sales being presented in a table

Question 23

What is the equation for the total cost function?

Answer 23

y=a + bx

a= the fixed cost per period
b= variable cost per unit
x = the activity level (independent variable)
y = total cost = fixed cost + variable cost (dependent variable)

Question 24

What is the calculation for finding the price?

Answer 24

Price = cost per unit + chosen margin or markup

Question 25

What is 'mark-up'?

Answer 25

the profit expressed as a percentage of cost (cost is 100%)

Question 26

What is 'margin'?

Answer 26

the profit expressed as a percentage of the sales price (sales is 100%_

Question 27

What is the main adv of standard costs?

Answer 27

the prices can be set in advance and fixed for the period concerned.

Question 28

What is the main dis adv of standard costs?

Answer 28

is that if significant variances occur, then the price may have been set too low and a loss ensues

Question 29

What is the main adv of actual costs?

Answer 29

a profit is guaranteed, however less incentive for the supplier to control costs as inefficiencies can be passed on to customers.

Question 30

What is the adv of marginal or full cost?

Answer 30

Simpler - no need for the absorption of fixed o/hs Consistent with the use of contribution in decision-making Useful in short-term decisions.

Question 31

What is the dis adv of marginal cost?

Answer 31

Setting an appropriate margin or markup as this will need to ensure all fixed costs are covered

Question 32

What are the advs of using relevant costs?

Answer 32

- can be used to arrive at a minimum tender price for a one-off tender or contract. - only suitable for one-off decisions

Question 33

How do you calculate price elasticity of demand PED?

Answer 33

Percentage change in demand / percentage change in price

Question 34

If PED < 1 what does this represent?

Answer 34

an inelastic product. This means demand is relatively insensitive to price changes

Question 35

If PED > 1 what does this represent?

Answer 35

An elastic product: demand is relatively sensitive to price changes. This could occur if the product has many substitutes, or is a luxury item

Question 36

What is market skimming?

Answer 36

- involves charging high prices when a product is first launched, to maximise short-term profitability

Question 37

What are the conditions suitable for market skimming?

Answer 37

- product is new and different - has little direct competition - short lifecycle and their is a need to recover development costs - firm with liquidity problems

Question 38

What is penetration pricing?

Answer 38

the charging of low prices when a new product is initially launched in order to gain rapid acceptance

Question 39

What are the conditions suitable for Penetration pricing?

Answer 39

- if a firm wishes to increase market share - if firm wishes to discourage new entrants from entering the market - if demand is highly elastic so would respond well to low prices

Question 40

What is a complentary product?

Answer 40

one that is normally used with another product. e.g., razors and razor blades

Question 41

What is a product line?

Answer 41

a range of products that are related to one another

Question 42

When does product line pricing occur?

Answer 42

when setting the price steps between various products in a product line, based on: - cost difference between the products - customer evaluations of different features - competitors prices

Question 43

What is volume discounting pricing?

Answer 43

offering customers a lower price per unit if they purchase a particular quantity of a product

Question 44

What are some benefits of volume discount pricing?

Answer 44

- increased customer loyalty - attracting new customers - lower sales processing costs

Question 45

What is pricing discrimination pricing?

Answer 45

where a company sells the same product or services at different prices in different markets

Question 46

What are some conditions required for a price-discrimination strategy?

Answer 46

- seller must have some degree of monopoly power - effective for services - there must be a different price elasticities of demand in each market so that prices can be raised in one and lowered in the other

Question 47

What are some issues with price discrimination?

Answer 47

- competitors join the market and undercut the firms prices - customers in the higher price bracket look for alternatives