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Managerial objectives and the Pricing Strategies

Extracts from this document...

Introduction

Managerial objectives and the Pricing Strategies Section 1: Managerial Objectives 1.1 The essence of managerial objectives We assumed that the firm's primary objective is to maximize profit. This assumption underlies the competitive environment, which we mapped out using the frameworks of the perfect competition, monopoly, monopolistic competition and oligopoly market models, and which allowed us to establish benchmarks for the analysis and comparison of price-output decisions under different market structures. This approach, often referred to as the traditional (or 'neoclassical') approach, can readily be criticized, however, on the grounds that it does not provide a satisfactory explanation of real-world production and pricing decisions. By assuming away many complexities, the simplistic assumption of profit maximization enables us to make very clear-cut predictions about the firm's behaviour However, it is one thing to make predictions, but another to say how realistic they are or how accurate they are. The traditional theory of the firm seems to be at its best when analyzing behaviour in perfectly competitive and monopoly market structures. In practice, however, these theoretical extremes are rarely to be found - in reality most firms are confronted with market conditions, which are more readily described as imperfectly competitive with oligopoly being the dominant market form. This is not to say that we should dismiss the analysis presented in the previous chapter - on the contrary, it is essential to the development of a deeper understanding of the fundamental relationships between pricing and production decisions. Most economists sympathize with the defence of the profit maximization assumption, recognizing its usefulness as a mental, theoretical link to explaining how one gets from the 'cause to the effect'. The market models reviewed in the last topics were developed to predict, not describe, behaviour in markets. Since the 195Os, however, a collection of new, alternative theories of corporate behaviour has been put forward. The purpose of this chapter is to review these theories and to assess their merits in terms of realism alongside the traditional approach. ...read more.

Middle

Once these products no longer exist, the overheads then must be allocated to the remaining products, putting their viability in jeopardy. All of the pricing strategies detailed in this chapter rely for their success on sound costing systems. 2.3.3 Breakeven pricing Breakeven pricing requires that the price of the product is set so that total revenue earned equals the total costs of production. Using simple arithmetic, we can calculate the breakeven output. For instance, if we are told that the unit sale price of a good is $20 per item and that the variable costs are $9 per unit with fixed costs of $330,000, the breakeven sales level is: At breakeven: total revenue (TR) = total costs (TC) = fixed costs (FC) + variable costs (VC) Therefore: $20 X quantity (q) = $330,000 + $9 X q Hence: q = 330,000/11 = 30,000 units. A breakeven point is illustrated in Figure 5. The breakeven, q, output (where TR = TC) is lower than that at which profit is maximized, i.e. q*. Like marginal cost pricing, breakeven pricing requires a detailed knowledge of the firm's cost and demand conditions. In practice, firms may only be able to identify with reasonable accuracy a 'breakeven area' rather than a breakeven point. For multi-product firms, breakeven analysis is much more complicated. Figure 5 Pricing strategies compared 2.3.4 Mark-up pricing Mark-up pricing is similar to breakeven pricing, except that a desired rate of profit is built into the price (hence this pricing is also sometimes referred to as cost-plus pricing, full-cost pricing or target-profit pricing). The particular mark-up will be what management consider appropriate or necessary to achieve a profit, which satisfies the shareholders. This might be equivalent to what the capital could earn if employed elsewhere in its next best alternative use (i.e. a 'normal' profit). For example, if the next best use generates a rate of return of 8%, then the capital would have to earn at least 8% in its current use or it would pay to invest elsewhere. ...read more.

Conclusion

Successful price discrimination requires an absence of arbitrage opportunities and differing elasticities of demand in the various markets. 20. First-degree price discrimination arises in the case of a producer selling each unit of output separately, charging a different price for each unit according to the consumer's demand function. This results in the transfer of all consumer surplus to the producer 21. Second-degree price discrimination involves charging a uniform price per unit for a specific quantity or block of output sold to each consumer 22. Third-degree price discrimination involves charging different prices for the same product in different segments of the market. The market may be segmented by geography, by type of demand, by time, or by the nature of the product itself. 23. In the case of a product produced by a multi-plant firm, the profit maximizing output rule (MR = MC) is unchanged, but in this case the marginal cost is the sum of the separate plants' marginal costs and production must be allocated between the plants so that marginal supply cost at each plant is identical. 24. The multi-product firm has to take into consideration not only the impact of a price change on the demand for the product, but also the impact on the demand for the other products in the firm's range. Pricing policy, therefore, involves obtaining the desired rate of return from the full product range rather than individual products. 25. Decentralization of firms brings with it problems of resource allocation, one aspect of which is the pricing of products which are transferred between divisions. This gives rise to the need for transfer pricing and the problem of determining the transfer price, which maximizes overall company profits. 26. Peak-load pricing involves differentiated pricing, which reflects differences in supply costs, given variations in demand for the product over time. 27. On the basis of the public interest rule, state enterprises should set prices in order to reflect the marginal social benefits from the additional output and the marginal social costs of producing that output. ...read more.

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