Pricing Policy

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 Objectives

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 Factors Influencing the Price of a Product

1. Price sensitivity- Sensitivity to price levels will vary

amongst purchasers
2. Price perception- the way customers react to prices.
3. Quality
4. Intermediaries- distributing the product through
others.
5. Competitors
6. Suppliers
7. Inflation
8. Exchange rate (new reality in Zimbabwe)
9. Incomes
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 Markets
The price that an organization can charge is determined
by the market in which it operates in:
1. Perfect competition – many buyers and sellers with
no one with no one having power on prices. Buyers
and sellers all deal with same product (Not realistic)
2. Monopoly- one seller who dominates many buyers.
Monopolist uses his power to maximize profit.
3. Monopolistic competition a large number of
suppliers offer similar, but not identical, products.
4. Oligopoly - where relatively few competitive
companies dominate the market.

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 Price and Demand Relationship
Factors that influence demand
1. Price
2. Income
3. Price of substitute goods (alternative)
4. Price of complementary
5. Taste
6. Market size
7. Advertising

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 Price Elasticity of Demand
Concept of price elasticity of demand
Price elasticity of demand
(a) The price elasticity of demand (PED) is a measure of the extent of change
in demand for a good in response to a change in its price. It is measured as:

The % change in quantity demanded

The % change in price

(b) Demand is referred to as inelastic if the absolute value is less than 1 and
elastic if the absolute value is greater than 1.

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 Price Elasticity of Demand
Example 1
The price of a good is $1.20 per unit and annual
demand is 800,000 units. Market research
indicates that an increase in price of 10 cents
per unit will result in a fall in annual demand of
75,000 units. What is the price elasticity of
demand?

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 Price Elasticity of Demand
Solution
% change in demand = (75,000 / 800,000) x 100% =
9.375%
% change in price = (0.1 / 1.20) x 100% = 8.333%
Price elasticity of demand = (–9.375/8.333) = –1.125

Ignoring the minus sign, price elasticity is 1.125

The demand for this good, at a price of $1.20 per unit,

would be referred to as elastic because the price elasticity
of demand is greater than 1.

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 Price Elasticity of Demand
Special values of price elasticity
There two special values of price elasticity of
demand
a) Perfectly inelastic (PED = 0).
b) Perfectly elastic (PED = ∞).

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 Price Elasticity of Demand
a) Perfectly inelastic
There is no change in quantity demanded,
regardless of the change in price. The demand
curve is a vertical straight line.

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 Price Elasticity of Demand
b) Perfectly elastic
Consumers will want to buy an infinite amount, but
only up to a particular price level.
Any price increase above this will reduce demand to
zero. The demand curve is a horizontal straight line.

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 PED and revenue relationship
• When demand is elastic, total revenue rises
as price falls and vice versa. This is because
the quantity demanded in very responsive to
price changes.
• When demand is inelastic, total revenue falls
as price falls because a fall in price causes a
less than proportionate rise in quantity
demanded.

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 Pricing Strategies
1. Cost-plus pricing- sales price is determined by
calculating the full cost of the product and adding a
percentage mark-up for profit.
2. Marginal cost-plus pricing- Marginal cost-plus
pricing/mark-up pricing involves adding a profit
margin to the marginal cost of production/sales.
3. Market skimming pricing- involves charging high
prices when a product is first launched in order to
maximize short-term profitability.
4. Market penetration pricing- pricing is a policy of low
prices when a product is first launched in order to
obtain sufficient penetration into the market.
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 Pricing Strategies
Points to note
Please read at the advantages and
disadvantages of pricing strategies discussed
above.
Revise full costing and marginal costing from
your earlier studies as that is key in cost plus
pricing and marginal cost plus.
Market skimming pricing and penetration
pricing have no calculations involved.
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 Example
Brick by Brick (BBB) is a building business that provides a range of building services to the
public. Recently they have been asked to quote for garage conversions (GC) and extensions to
properties (EX) and have found that they are winning fewer GC contracts than expected.

BBB has a policy to price all jobs at budgeted total cost plus 50%. Overheads are curr ently
absorbed on a labour hour basis. BBB thinks that a switch to activity based costing (ABC) to
absorb overheads w ould reduce the cost associated to GC and hence make them more
competitive.

You are provided with the following data:

Overhead Annual Activity driver Total number of

category overheads ($) activities per year
Supervisors 90,000 Site visits 500
Planners 70,000 Planning documents 250
Property related 240,000 Labour hours 40,000
400,000

A typical GC costs $3,500 in materials and takes 300 labour hours to complete. A GC requires
only one site visit by a supervisor and needs only one planning document to be raised. The
typical EX costs $8,000 in materials and takes 500 hours to complete. An EX requires six site
visits and fi ve planning documents. In all cases labour is paid $15 per hour.

Required:

(a) Calculate the cost and quoted price of a GC and of an EX using labour hours to absorb
the overheads. (5 marks)
(b) Calculate the cost and the quoted price of a GC and of an EX using ABC to absorb the
overheads.

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 Example- Answer

(a)
Costs and quoted prices for the GC and EX using labour hours to absorb overheads:
GC ($) EX ($)
Materials 3,500 8,000
Labour 300 hrs x $15/hr 4,500
500 hrs x $15/hr 7,500
Overheads 300 hrs x $10/hr (W1) 3,000
500 hrs x $10/hr 5,000
Total cost 11,000 20,500

Quoted price 16,500 30,750

(W1) Overhead absorption rate is calculated as $400,000/40,000 hrs = $10/hr

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 Example- Answer
(b)
Costs and quoted prices for the GC and the EX using ABC to absorb overheads:
GC ($) EX ($)
Materials 3,500 8,000
Labour 300 hrs x $15/hr 4,500
500 hrs x $15/hr 7,500
Overhead
- Supervisor (W2)/(W3) 180 1,080
- Planners (W2)/(W3) 280 1,400
- Property (W2)/(W3) 1,800 3,000
Total cost 10,260 20,980

Quoted price 15,390 31,470

(W2)
Costs No. of drivers Cost per driver
Supervisor 90,000 500 180
Planners 70,000 250 280
Property 240,000 40,000 6

(W3)
Supervisor Planner Property
Cost per driver (W2) $180 $280 $6
GC 180 x 1 = 180 280 x 1 = 280 6 x 300 = 1,800
EX 180 x 6 = 1,080 280 x 5 = 1,400 6 x 500 = 3,000

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 END

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