Pricing Practices
Copyright  2007 by Oxford University Press, Inc.
Pricing
Price
• Is the monetary value of a unit of a
good, service, asset of factor input.
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.
Copyright  2007 by Oxford University Press, Inc.
Slide 2
Pricing
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Pricing Objectives
Survival
Profit Maximization
Target
Return on Investment (ROI)
Market Share Goals
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Pricing
Pricing Methods
• Cost-based pricing
• Demand-based pricing
• Competition-based pricing
Copyright  2007 by Oxford University Press, Inc.
Pricing
Cost-Based Pricing
• Markup – price is determined by adding
an amount to the wholesale price
• Markdown – subtracting an amount
from the retail price
Copyright  2007 by Oxford University Press, Inc.
Pricing
Advantages & Disadvantages of
Cost-Based Pricing Advantages
• Easy to apply
• Commonly used by retailers and
wholesalers
Disadvantages:
• Difficult to determine an effective
markup percentage
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Pricing
Disadvantages (cont)
• Separates pricing from other business
functions
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Pricing
Demand-Based Pricing
• That is determined by how much
customers are willing to pay for a
product or service
• This method results in a high price
when demand is strong and a low price
when demand is weak
Copyright  2007 by Oxford University Press, Inc.
Pricing
Demand-Based Pricing (cont)
• May be differentiated based on
considerations such as time of
purchase, type of customer or
distribution channel
Copyright  2007 by Oxford University Press, Inc.
Pricing
Advantages and Disadvantages of
Demand-Based Pricing
Advantage:
• Potential for higher profits
Disadvantage:
• Management must be able to estimate
demand at different price levels, which
may be difficult to do accurately
Copyright  2007 by Oxford University Press, Inc.
Pricing
Disadvantages of Demand-Based
Pricing (cont)
• Segments must be separate enough so
that those that buy at lower prices can’t
sell to those who buy at higher prices
Copyright  2007 by Oxford University Press, Inc.
Pricing
Competition-Based Pricing
• That is determined by considering what
competitors charge for the same good.
• Once you find out what your competition
is charging, you must determine
whether to charge the same, slightly
more, or slightly less
Copyright  2007 by Oxford University Press, Inc.
Pricing
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Pricing Strategies
Psychological pricing
Product line pricing
Promotional pricing
Discounting
Copyright  2007 by Oxford University Press, Inc.
Pricing
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Psychological Pricing :
Odd-number pricing
Multiple-unit pricing
Reference pricing
Bundle pricing
Everyday low price (EDLP)
Customary pricing
Copyright  2007 by Oxford University Press, Inc.
Pricing
Product Line Pricing
• Establishing and adjusting the prices of
multiple products within a product line
• Captive pricing – basic product low, but
items required to operate or enhance it
can be at a high level
Copyright  2007 by Oxford University Press, Inc.
Pricing
Product Line Pricing (cont)
• Premium pricing – highest quality or
most versatile version is given the
highest price
• Price lining – setting a limited number of
prices for selected groups or lines of
merchandise
Copyright  2007 by Oxford University Press, Inc.
Pricing
Promotional Pricing
• Price leaders
• Special event pricing
• Comparison discounting
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Pricing
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Discounting
Trade discounts
Quantity discounts
Cash discounts
Seasonal discount
Allowance
Copyright  2007 by Oxford University Press, Inc.
Pricing
• Breakeven Analysis
• Answers the question, “What is the lowest
level of production and sales at which a
company can break even on a particular
product?”
• Breakeven quantity – the number of units that
must be sold for the total revenue to equal
the total cost (for all units sold)
Copyright  2007 by Oxford University Press, Inc.
Pricing
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Breakeven Analysis
Fixed costs – $40,000
Variable costs – $60 per unit
Selling price – $120 per unit
What is the breakeven quantity?
Copyright  2007 by Oxford University Press, Inc.
Price Discrimination
Charging different prices for a product
when the price differences are not
justified by cost differences.
Objective of the firm is to attain higher
profits than would be available
otherwise.
Copyright  2007 by Oxford University Press, Inc.
Price Discrimination
1.Firm must be an imperfect competitor (a
price maker)
2.Price elasticity must differ for units of
the product sold at different prices
3.Firm must be able to segment the
market and prevent resale of units
across market segments
Copyright  2007 by Oxford University Press, Inc.
First-Degree
Price Discrimination
• First degree creates different prices for
each customer (maximum profits)
• Each unit is sold at the highest possible
price
• Firm extracts all of the consumers’
surplus
• Firm maximizes total revenue and profit
from any quantity sold
Copyright  2007 by Oxford University Press, Inc.
Second-Degree
Price Discrimination
• Second degree gives quantity
discounts.
• Charging a uniform price per unit for a
specific quantity, a lower price per unit
for an additional quantity, and so on
• Firm extracts part, but not all, of the
consumers’ surplus
Copyright  2007 by Oxford University Press, Inc.
Copyright  2007 by Oxford University Press, Inc.
First- and Second-Degree
Price Discrimination
In the absence of price discrimination, a firm
that charges $2 and sells 40 units will have
total revenue equal to $80.
Copyright  2007 by Oxford University Press, Inc.
First- and Second-Degree
Price Discrimination
In the absence of price discrimination, a firm
that charges $2 and sells 40 units will have
total revenue equal to $80.
Consumers will have consumers’ surplus
equal to $80.
Copyright  2007 by Oxford University Press, Inc.
First- and Second-Degree
Price Discrimination
If a firm that practices first-degree price
discrimination charges $2 and sells 40 units,
then total revenue will be equal to $160 and
consumers’ surplus will be zero.
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.
Copyright  2007 by Oxford University Press, Inc.
Slide 28
First- and Second-Degree
Price Discrimination
If a firm that practices second-degree price
discrimination charges $4 per unit for the first
20 units and $2 per unit for the next 20 units,
then total revenue will be equal to $120 and
consumers’ surplus will be $40.
Copyright  2007 by Oxford University Press, Inc.
Third-Degree
Price Discrimination
• Third degree assigns different prices by
customer age, sex, income, etc. (most
common).
• Charging different prices for the same
product sold in different markets
• Firm maximizes profits by selling a quantity
on each market such that the marginal
revenue on each market is equal to the
marginal cost of production
Copyright  2007 by Oxford University Press, Inc.
Copyright  2007 by Oxford University Press, Inc.
Copyright  2007 by Oxford University Press, Inc.
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International
Price Discrimination
• Persistent Dumping
• Predatory Dumping
– Temporary sale at or below cost
– Designed to bankrupt competitors
– Trade restrictions apply
• Sporadic Dumping
– Occasional sale of surplus output
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Transfer Pricing
• Pricing of intermediate products sold by
one division of a firm and purchased by
another division of the same firm
• Made necessary by decentralization
and the creation of semiautonomous
profit centers within firms
Copyright  2007 by Oxford University Press, Inc.
Copyright  2007 by Oxford University Press, Inc.
Copyright  2007 by Oxford University Press, Inc.
Copyright  2007 by Oxford University Press, Inc.
Multiple-product Pricing
• Demand Interrelations
– Cross-marginal revenue terms indicate
how product revenues are related to
another.
• Production Interrelations
– Joint products may compete for resources
or be complementary.
– A by-product is any output customarily
produced as a direct result of an increase
in the production of some other output.
Copyright  2007 by Oxford University Press, Inc.
Joint Products
• Joint Products in Variable Proportions
– If products are produced in variable proportions,
they are distinct outputs.
– For joint products produced in variable
proportions, set MRA= MCA and MRB= MCB.
– Allocation of common costs is wrong and arbitrary.
• Joint Products in Fixed Proportions
– Some products are produced in a fixed ratio.
– If Q = QA= QB, set MRQ= MRA+ MRB = MCQ.
Copyright  2007 by Oxford University Press, Inc.
Joint Product Pricing Example
• Joint Products Without Excess By-product
– Profit-maximization requires setting MRQ=
MRA+MRB = MCQ.
– Marginal revenue from each byproduct makes a
contribution toward covering MCQ.
• Joint Production With Excess By-product
(Dumping)
– Profit-maximization requires setting MRQ=
MRA+MRB= MCQ.
– Primary product marginal revenue covers MCQ.
– Byproduct MR=MC=0.
Copyright  2007 by Oxford University Press, Inc.