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Learning Objective 15-1 – List and describe
the four major influences on pricing decisions.
15-2
Major Influences on
Pricing Decisions
Pricing
Decisions
Competitors Costs
15-3
Learning Objective 15-2 – Explain and use
the economic, profit-maximizing pricing model.
15-4
How Are Prices Set?
Market
Costs
Forces
15-5
Economic Profit-Maximizing Pricing
15-6
Total Revenue Curve
Dollars
Total revenue
Quantity sold
per month
15-7
Demand Schedule and
Marginal Revenue Curve
Dollars
per unit
Demand
Revenue per Marginal
unit decreases revenue
as quantity increases Quantity sold
per month
15-8
Total Cost Curve
Dollars
Quantity made
c per month
15-10
Determining the Profit-Maximizing
Price and Quantity
Dollars
per unit
p*
Demand
Marginal
cost Marginal Quantity made
revenue
q* and sold
per month 15-11
Determining the Profit-Maximizing
Price and Quantity
Dollars
per unit Profit is maximized where
marginal cost equals
marginal revenue, resulting
p* in price p* and quantity q*.
Demand
Marginal
cost Marginal Quantity made
revenue
q* and sold
per month 15-12
Determining the Profit-Maximizing
Price and Quantity
Dollars Total cost
Total revenue
Quantity made
q* and sold
per month 15-13
Price Elasticity
The impact of
price changes on
sales volume
15-14
Cross Elasticity
The extent to
which a change in
a product’s price affects the
demand for other
substitute products.
15-15
Limitations of the
Profit-Maximizing Model
15-16
Role of Accounting
Product Costs in Pricing
Optimal Decisions Suboptimal Decisions
Economic pricing model Cost-based pricing
Sophisticated decision Simplified decision
model and information model and information
requirements requirements
15-18
Cost-Plus Pricing
15-20
Cost-Plus Pricing - Example
Variable mfg. cost $ 400
Markup on
Fixed mfg. cost 250
variable
Full-absorption mfg. cost $ 650
manufacturing
Variable S & A cost 50
cost.
Fixed S & A cost 100
Total cost $ 800
15-21
Cost-Plus Pricing - Example
Markup on
Variable mfg. cost $ 400 total var. cost
Fixed mfg. cost 250 As cost base
Full-absorption mfg. cost $ 650 increases, the
Variable S & A cost 50 required markup
Fixed S & A cost 100 percentage
Total cost $ 800 declines.
15-22
Cost-Plus Pricing - Example
Markup on
Variable mfg. cost $ 400 full mfg. cost
Fixed mfg. cost 250 As cost base
Full-absorption mfg. cost $ 650 increases, the
Variable S & A cost 50 required markup
Fixed S & A cost 100 percentage
Total cost $ 800 declines.
15-23
Cost-Plus Pricing - Example
Markup on
Variable mfg. cost $ 400 total cost
Fixed mfg. cost 250 As cost base
Full-absorption mfg. cost $ 650 increases, the
Variable S & A cost 50 required markup
Fixed S & A cost 100 percentage
Total cost $ 800 declines.
15-24
Absorption-Cost Pricing Formulas
Advantages Disadvantages
Price covers all costs. Full-absorption unit
Perceived as equitable.
price obscures the
distinction between
Comparison with variable and fixed
competitors. costs.
Absorption cost used
for external reporting.
15-25
Variable-Cost Pricing Formulas
Advantages Disadvantage
Does not obscure cost Fixed costs may be
behavior patterns. overlooked in
Does not require fixed pricing decisions,
cost allocations. resulting in prices
that are too low to
More useful for cover total costs.
managers.
15-26
Determining the Markup:
Return-on-Investment Pricing
15-27
Determining the Markup:
Return-on-Investment Pricing
15-28
Determining the Markup:
Return-on-Investment Pricing
Step 1: Solve for the income that
will result in an ROI of 20 percent.
Income
ROI =
Invested Capital
Income
20% =
$300,000
Income = 20% × $300,000
Income = $60,000
15-29
Determining the Markup:
Return-on-Investment Pricing
Step 2: Recall the unit cost information below.
Solve for the unit sales price necessary to
result in an income of $60,000.
$60,000
Unit sales price - $800 unit cost =
480 units
Unit sales price - $800 unit cost = $125 per unit
Unit sales price = $925
15-31
Determining the Markup:
Return-on-Investment Pricing
Step 3: Compute the markup percentage on
the $400 variable manufacturing cost.
15-33
Strategic Pricing of New Products
Uncertainties make pricing difficult.
Production costs.
Market acceptance.
Pricing Strategies:
Skimming – initial price is high with intent to
gradually lower the price to appeal to a broader
market.
Market Penetration – initial price is low with
intent to quickly gain market share.
15-34
Learning Objective 15-5 – List and discuss
the key principles of target costing.
15-35
Target Costing
Market research
determines the price Management computes
at which a new a manufacturing cost that
product will sell. will provide an acceptable
profit margin.
15-38
The Role Of Activity-Based
Costing In Setting A
Target Cost
Production Process
Component Activities
15-39
Learning Objective 15-7 – Explain how
product-cost distortion can undermine a firm’s
pricing strategy.
15-40
Product Cost Distortion
High-volume products
may be overcosted
Low-volume
products
may be undercosted
15-41
Learning Objective 15-8 – Explain the process
of value engineering and its role in target costing.
15-42
Value Engineering
Target Costing
sting
Target cost information
Product design
Product costs
Production processes
15-43
Learning Objective 15-9 – Determine prices
using the time and material pricing approach.
15-44
Time and Material Pricing
Material Charges:
Total Overhead Total
material per dollar material
cost
+ of material × cost
incurred cost incurred
15-46
Learning Objective 15-10 – Set prices in
special-order or competitive-bidding situations by
analyzing the relevant costs.
15-47
Competitive Bidding
15-48
Competitive Bidding
Guidelines for Bidding
Low bid price
Any bid price in excess of
Bidder has
incremental costs of job
excess capacity will contribute to fixed
costs and profit.
High bid price
Bid price should be full
Bidder has no cost plus normal profit
excess capacity margin as winning bid will
displace existing work.
15-49
Learning Objective 15-11 – Describe the
legal restrictions on setting prices.
15-50
Legal Restrictions On Setting Prices
Price
discrimination
Predatory pricing
15-51
End Chapter 15
15-52