1. Discuss the role of cost and demand factors
in setting a price.
2. Apply break-even analysis and markup pricing.
3. Identify specific pricing strategies.
4. Explain the benefits of credit, factors that affect
credit extension, and types of credit.
5. Describe the activities involved in managing credit.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
16–2
Setting a Price
• Price
 A specification of what a seller requires in exchange
for transferring ownership or use of a product or
service.
Prices set too low, loss in revenue
 Price set too high, loss in revenue
 Price and demand are related for many goods and services

• Credit
 An agreement between a buyer and a seller that
provides for delayed payment for a product or service.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
16–3
Price Changes Affect Revenues
Situation A
Quantity sold x Price per unit = Gross revenue
250,000
$3.00
$750,000
Situation B
Quantity sold x Price per unit = Gross revenue
250,000
$2.80
$700,000
Difference in Revenue
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
$50,000
16–4
Cost Determination for Pricing
• Total Cost
 The sum of cost of goods sold, selling expenses, and
overhead costs.
• Variable Costs
 Costs that vary with the quantity produced or sold.
• Fixed Costs
 Costs that remain constant as the quantity product or
sold varies.
• Average Pricing
 An approach in which total cost for a given period is
divided by quantity sold in that period to set a price.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
16–5
16.1
Cost Structure of a Hypothetical Firm, 2013
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
16–6
16.2
Cost of Structure of a Hypothetical Firm, 2014
Average pricing overlooks the reality of
higher average costs at lower sales levels
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
16–7
How Customer Demand Affects Pricing
• Elasticity of Demand
 The degree to which a change in price
affects the quantity demanded.
 Elastic Demand

Demand that changes
significantly when there
is a change in the price
of the product.
Price
 Inelastic Demand

Demand that does not change
significantly when there is a
change in the price of the product.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Inelastic
Elastic
Demand
16–8
Pricing and Competitive Advantage
• Pricing and a Firm’s Competitive Advantage
 Customers will demand and pay more for
a product or service that they perceive as important to
their needs.
• Prestige Pricing
 Setting a high price to convey an image of high
quality or uniqueness (competitive advantage).
 Customers associate price with quality.
 Markets with low levels of product knowledge
are candidates for prestige pricing.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
16–9
Applying a Pricing System
• Break-Even Analysis
 A comparison of alternative cost and revenue
estimates in order to determine the acceptability
of each price.
 Steps in the analysis

Examining revenue-cost relationships: the quantity at
which the product will generate enough revenue to start
earning a profit.
Break-even
units sold
=
total fixed costs and expenses
selling price – unit variable costs and expenses
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
16–10
16.3
Break-Even Graphs for Pricing
units
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
16–11
Applying a Pricing System (cont’d)
• Examining Cost and Revenue Relationships
 Breakeven point

The sales volume at which total sales revenue equals
total costs (fixed and variable)—the point at which
profitability starts and losses cease.
 Contribution margin

The difference between the unit selling price
and the unit variable costs and expenses.
• Incorporating Sales Forecasts
 Adjusted Break-Even Analysis
Price has a variable impact and influence on demand.
 Adjusting for the indirect effect of price allows for a more
realistic profit area to be identified.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
16–12
16.4
A Break-Even Graph Adjusted for Estimated Demand
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
16–13
Applying a Pricing System (cont’d)
• Markup Pricing
 Cost plus pricing system that adds
a markup percentage to cover:
Operating expenses
 Subsequent price reductions
 Desired profit

Markup
 100  Markup as a percentage
of selling price
 100  Markup as a percentage
of cost
Selling Price
Markup
Cost
Retail adage: Markup on purchased cost, markdown on selling price
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
16–14
Selecting a Pricing Strategy
Penetration
Pricing
Follow-theLeader Pricing
Skimming
Pricing
Pricing
Strategies
Variable
Pricing
Price
Lining
Dynamic
Pricing
What the Market
Will Bear:
Adaptive Pricing
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
16–15
Selecting a Pricing Strategy (cont’d)
• Setting Prices: Controls and Situations
 The Sherman Antitrust Act generally prohibits
competitors from conspiring to fix prices.
 The effect of the introduction of new products into an
established product line.
 Offering discounts to match the needs of customers.
 If the initial price appears to be off target, make any
necessary adjustments and keep on selling!
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
16–16
Offering Credit
• Benefits of Credit to Borrowers
 Provides working capital
 Ability to satisfy immediate needs and pay later
 Better records of purchases on credit billing
 Better service and greater convenience when
exchanging purchased items
 Establishment of credit history
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
16–17
Offering Credit (cont’d)
• Benefits of Credit to Sellers
 Facilitates increased sales volume.
 Brings a closer association with customers.
 Fosters easier selling through telephone, mail
and over the Internet.
 Helps smooth sales demand since
purchasing power is always available.
 Provides easy access to a tool
with which to stay competitive.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
16–18
Selling on Credit
Factors that Affect
Selling on Credit
Type of
business
Credit
policies of
competitors
Income level
of customers
Availability
of working
capital
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Economic
conditions
16–19
Types of Credit
• Consumer Credit
 Financing granted by retailers to individuals who
purchase for personal or family use.
• Trade Credit
 Financing provided by a supplier of inventory to a
given company which sets up an account payable for
the amount.

Terms of sale may be 2/10, net 30—two percent discount on
the invoiced amount if paid in full within 10 days of the invoice
date, otherwise the full invoice amount is due in 30 days.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
16–20
Types of Consumer Credit Accounts
• Open Charge Account
 Is a line of credit that allows the customer to obtain a
product at the time of purchase.
• Installment Account
 Is a line of credit that requires a down payment, with
the balance paid over a specified period of time.
• Revolving Charge Account
 Is a line of credit on which the customer may charge
purchases at any time, up to a pre-established limit.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
16–21
Types of Credit Cards
• Bank Credit and Debit Cards
 Are issued by banks that are widely accepted by
retailers who pay a fee to the banks for handling their
credit transactions.
• Travel and Entertainment Credit Cards
 Were originally used to purchase services, now
widely accepted for merchandise.
• Retailer Credit Cards
 Are issued by firms for specific use in their retail
outlets or for purchasing their products or services.
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
16–22
Managing the Credit Process
• Evaluation of Credit Applicants
 Can the buyer pay as promised?
 Will the buyer pay?
 If so, when will the buyer pay?
 If not, can the buyer be forced to pay?
• The Traditional Five C’s of Credit
 Character
 Capacity
 Capital
 Collateral
 Conditions
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
16–23
Sources of Credit Information
• Individuals
 Customer’s previous credit history
 Credit information exchanges
• Businesses
 Financial statements of the firm
 Other sellers to the firm
 Firm’s banker
 Trade-credit agencies
 Credit bureaus
 Online credit data
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
16–24
16.5
Hypothetical Aging Schedule for Accounts Receivable
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
16–25
Managing the Credit Process (cont’d)
• Billing and Collection Procedures
 Timely notification is a most effective collection
method for keeping bills current.
 Warning consumers that they may do damage to their
credit if they fail to pay.
• Bad Debt Ratio
 A number obtained by dividing the amount of bad
debts by the total amount of credit sales.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
16–26
Credit Regulation
• The Truth-in-Lending Act (1968)
• The Fair Credit Billing Act
• The Fair Credit Reporting Act
• The Equal Credit Opportunity Act
• The Fair Debt Collection Practices Act
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
16–27
Key Terms
adaptive pricing
aging schedule
average pricing
bad-debt ratio
break-even analysis
break-even point
consumer credit
contribution margin
credit bureaus
credit card
credit
debit card
elastic demand
elasticity of demand
follow-the-leader pricing strategy
inelastic demand
installment account
markup pricing
open charge account
penetration pricing strategy
prestige pricing
price lining strategy
revolving charge account
skimming price strategy
trade credit
trade-credit agencies
value
variable pricing strategy
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
16–28