Major Influences on Pricing Decisions

Four major influences govern the prices set by Sydney Sailing Supplies:

a. Customer demand.
The demands of customers are of paramount importance in all phases of business
operations, from the design of a product to the setting of its price. Product-design issues and
pricing considerations are interrelated, so they must be examined simultaneously. On the
other hand, management must be careful not to price its product out of the market.
Discerning customer demand is a critically important and continuous process.

b. Actions of competitors.
Domestic and foreign competitors are striving to sell their products to the same customers.
Thus, as Sydney Sailing Supplies’ management designs products and sets prices, it must keep
a watchful eye on the firm’s competitors. If a competitor reduces its price on sailboats of a
particular type, Sydney Sailing Supplies may have to follow suit to avoid losing its market
share Yet the company cannot follow its competitors blindly either. Predicting competitive
reactions to its product design and pricing strategy is a difficult but important task for
Sydney Sailing Supplies’ management.

c. Costs.
The role of costs in price setting varies widely among industries. In some industries, prices
are determined almost entirely by market forces. An example is the agricultural industry,
where grain and meat prices are market-driven. Farmers must meet the market price. To
make a profit, they must produce at a cost below the market price. This is not always
possible, so some periods of loss inevitably result. Managers have some latitude in
determining the markup, so market forces influence prices as well. In public utilities, such as
electricity and natural gas companies, prices generally are set by a regulatory agency of the
state government.

d. Political, legal, and image-related issues.

In the legal area, managers must adhere to certain laws. The law generally prohibits
companies from discriminating among their customers in setting prices. Political
considerations also can be relevant. For example, if the firms in an industry are perceived by
the public as reaping unfairly large profits, there may be political pressure on legislators to
tax those profits differentially or to intervene in some way to regulate prices. Companies
also consider their public image in the price-setting process. A firm with a reputation for very
high-quality products may set the price of a new product high to be consistent with its
image.

Economic Profit-Maximizing Pricing

a. Total Revenue, Demand, and Marginal Revenue Curves

The trade-off between a higher price and a higher sales quantity can be shown in the shape
of the firm’s total revenue curve, which graphs the relationship between total sales revenue
and quantity sold.
 Total Revenue Curve
 The trade-off between a higher price and a higher sales quantity can be shown in the
shape of the firm’s total revenue curve, which graphs the relationship between total
sales revenue and quantity sold.

 Demand (or Average Revenue) Curve and Marginal Revenue Curve

The demand curve shows the relationship between the sales price and the quantity
of units demanded. The demand curve decreases throughout its range, because any
decrease in the sales price brings about an increase in the monthly sales quantity.
The marginal revenue curve shows the change in total revenue that accompanies a
change in the quantity sold. The marginal revenue curve is decreasing throughout its
range to show that total revenue increases at a declining rate as monthly sales
quantity increases.

 Tabulated Price, Quantity, and Revenue Data

b. Total Cost and Marginal Cost Curves
Panel A of Exhibit 15–2 displays the firm’s total cost curve, which graphs the relationship
between total cost and the quantity produced and sold each month.1 Total cost increases
throughout its range. The rate of increase in total cost declines as quantity increases from
zero to c units. To verify this, notice that the increase in total costs when quantity increases
from zero to a units is greater than the increase in total costs when quantity increases from
a units to b units. Closely related to the total cost curve is the marginal cost curve, which is
graphed in panel B of Exhibit 15–2. The marginal cost curve shows the change in total cost
that accompanies a change in quantity produced and sold. Marginal cost declines as quantity
increases from zero to c units; then it increases as quantity increases beyond c units.
c. Profit-Maximizing Price and Quantity
Total Cost and Marginal Cost Curves
 Total Cost Curve

 Marginal Cost Curve

 Tabulated Cost and Quantity Data

Determining the Profit Maximizing Price and Quantity

 Total Revenue and Total Cost Curves

 Marginal Revenue and Marginal Cost Curves

  Tabulated Revenue, Cost, and Profit Data

d. Price Elasticity
The impact of price changes on sales volume is called the price elasticity. Demand is elastic if
a price increase has a large negative impact on sales volume, and vice versa. Demand is
inelastic if price changes have little or no impact on sales quantity. Cross elasticity refers to
the extent to which a change in a product’s price affects the demand for other substitute
products. Measuring price elasticity and cross-elasticity is an important objective of market
research. Having a good understanding of these economic concepts helps managers to
determine the profit-maximizing price.
e. Limitations of the Profit-Maximizing Model
Model ekonomi dari keputusan penetapan harga berfungsi sebagai kerangka kerja yang
berguna untuk mendekati masalah harga.However, it does have several limitations. First, the
firm’s demand and marginal revenue curves are difficult to discern with precision. Second,
the marginal-revenue, marginal-cost paradigm is not valid for all forms of market
organization. In an oligopolistic market, where a small number of sellers compete among
themselves, the simple economic pricing model is no longer appropriate. In an oligopoly,
such as the automobile industry, the reactions of competitors to a firm’s pricing policies
must be taken into account. The third limitation of the economic pricing model involves the
difficulty of measuring marginal cost. Cost accounting systems are not designed to measure
the marginal changes in cost incurred as production and sales increase unit by unit. To
measure marginal costs would entail a very costly information system.
f. Costs and Benefits of Information
For this reason, most managers make pricing decisions based on a combination of economic
considerations and accounting product-cost information. In spite of its limitations, the
marginal-revenue, marginal-cost paradigm of pricing serves as a useful conceptual
framework for the pricing decision. Within this overall framework, managers typically rely
heavily on a cost-based pricing approach, as we shall see next.
Cost-Benefit Trade-Off in Information Production