Pricing methods: (10 marks)
Today the management (of the firms) has more objectives than one (profit maximization). Hencedifferent pricing methods are adopted. They are:a.
Cost oriented pricingb.
Competition oriented pricingc.
Pricing based on other economic considerationsCost oriented pricing: Most firms prefer this method because:a.
It is easy to calculateb.
It is very satisfactory as it takes care of uncertainties and ignorancec.
It is scientific and there is no doubt in this method
The marginal cost pricing (Direct cost pricing):
This method implies that the price of the product is based on the incremental cost of production unlikethe full cost pricing which is based on average cost, the incremental or marginal cost pricing is basedon the variable cost only (The difference between the two being fixed cost only). While the full costpricing is a long period phenomenon, the incremental cost pricing is a short period phenomenon.This method allows a firm to develop a far more aggressive pricing policy than does the full costpricing.This method does not provide a long period stable pricing policy. Many people are not even aware of marginal cost pricing methods. When is the marginal cost pricing method used?a.
When the firm wants to introduce its products into the new marketsb.
When a firm faces stiff competition or when it has unutilized capacityWhen a firm equates MC with MR at that level of output it maximizes its profits. An additional unitproduced over and above this may increase the cost hence profit maximization is affected. Todayfirms have better objectives than profit maximization. It is sales promotion, maximization of growthetc. Long term survival and growth is the aim of the firms. So the MC pricing has become outdated.
Average Cost or Full cost pricing:
This principle is used by a large number of firms both small and large. According to Hall and Hitch, thefirms usually oligopolistic in nature did not use the marginal rule i.e. MC = MR to determine the price.So these firms did not attempt to maximize their profits. Firms aim at long run profit maximization.Firms determine their price by applying the full cost principle. The full cost principle suggests thatfirms set a price to cover the average variable cost, the average fixed cost and normal profit margin(NPM)P = AVC + AFC + NPMWhy was the marginalist principle abandoned?According to Hall and Hitch, the firms in practice never know their demand curve. They also do notknow their marginal costs. So due to lack of relevant information, the firms find it difficult to followthe marginalist principle.