In fact, pricing is the most crucial and complicated decision with which the company is dealing.
This is because on this depend the market strategies, competition, survival and many long- as well
as short-term decisions.
Before understanding the pricing in different markets, we should first understand the term \u201cpricing.\u201d Pricing of a product is governed primarily by its cost of production and the nature of competition being faced by the production unit. Once market forces fix the price, it remains stable at least in the short-term. During short period when selling price, marginal cost and fixed costs remain the same, an entrepreneur is in a position to establish relationship between them. On the basis of such a relationship, it is easy to fix the volume of sales and selling price during normal and abnormal times in the home market.
The firm is thinking to reduce the selling price due to severe competition to Rs. 10.80 per unit (10% decrease). How much extra should it produce and sell if the previous level of profit is to be maintained?
As a result of the decrease in selling price by 10%, the profits of the firm will be reduced to Rs. 29,400 if no effort for additional sales is made. Since the firm has decided to maintain the present level of profit, i.e. Rs. 53,400, it will need additional sales to counter balance the loss due to price reduction. The number of units required to be sold to maintain the existing levels of profit is calculated as under:
A foreign market can be kept separate from the domestic market due to many legal and other restrictions imposed on imports and exports. As such a different price can be charged from foreign buyers. Any company which enjoys surplus production capacity can increase its production to sell in the foreign market at lower prices if its full fixed cost already stands recovered from the sales in the home market. Any price in excess of the marginal cost will lead to more revenue. This aspect is explained in the following example:
Light Lamp Ltd. is operating at 60% of its installed capacity and producing 27,000 units. These are sold in the domestic market at a price of Rs. 15 per unit. The marginal cost of production is Rs. 12 per unit and the fixed cost amounts to Rs. 15,000.
The company has received a foreign offer to purchase 9,000 units of its product at a price of Rs. 13.50 per unit. The company will have to incur nothing on additional fixed cost. However, it will have to bear Rs. 0.75 per unit as distribution cost in respect of foreign buyer.
Less: Distribution cost of
export of 9,000 units
@ Rs. 0.75 per unit
The above cost statement clearly shows that the company should accept the foreign offer as it will generate an extra profit of Rs. 6,750. If the buyer is a local one, the company will have to keep this buyer separate from other buyers for additional supply of 9000 units @ Rs. 13.50. Otherwise, other customers will also ask for price reduction and the company will be put to difficulties.
Recession is an economic condition under which demand declines. During depression, the demand is at its lowest ebb and the firms are confronted with the problem of price reduction and closure of production.
Under such conditions, the marginal costing technique suggests that prices can be reduced to a level of marginal cost. In that case, the firm will loose profits and also suffer loss to the extent of fixed costs. This loss will also be borne even if the production is suspended altogether. Selling below marginal cost is advisable only under very special circumstances.
This action might not be possible to undo. Are you sure you want to continue?