Transcript Chapter-II

CH 2
The Economics of Price Determination
Kent B. Monroe (2007). Pricing: Making Profitable Decisions.
3rd Edition (Singapore: McGraw-Hill) .
Chapter Objectives (P.26)
02
1. To summarize the traditional neoclassical economic theory of price
determination
2. To introduce some useful concepts for actual pricing decisions such as
revenue, elasticity, marginal revenue, marginal costs etc.
Price Determination Theory (P.26-27)
03
• Minimize input cost
• Maximize profit
The firm
Economic theory is more concerned with the behavior
of aggregates or markets, particularly how persistent
and widespread behavior leads to stable results called
“Equilibrium”.
Price Determination Theory (P.26-27)
04
Economic Perspective
• The firm is a pricetaker, not the pricemaker
• Management determines the quantity to
produce
• The market sets price through the forces of
supply and demand
Marketing Perspective
• Price is a decision variable.
05
The Profit-Maximizing Firm (P. 28)
$
Revenues
or
Costs
Maximum Profits
Total Costs
Total Revenue
Price
Fixed costs
0
Q1
Q*
Q Units
Figure 2.1 Output Determination for Profit-Maximizing Firm – Short Run
(Constant Prices) : Aggregate Analysis
06
The Profit-Maximizing Firm (P. 28)
$
Costs
Marginal cost
Average cost
Price
(Marginal revenue)
0
Q*
Q
Units
Figure 2.2 Output Determination for Profit-Maximizing Firm – Short Run
(Constant Prices) : Marginal Analysis
07
The Profit-Maximizing Firm (P. 29)
$
Price
Marginal cost
P*
Demand
(Marginal revenue)
0
Q*
Q
Units
Figure 2.3 Output Determination for Profit-Maximizing Firm – Short Run
(Varying Prices)
Corporate and Pricing Objective (P. 30)
10
Pricing objectives should be
consistent with & should advance
corporate & marketing objectives
The organization’s specific
marketing objectives are based
on those corporate objectives.
Setting objectives for one
element of the marketing mix.
3 Classifications of Pricing Objectives (P. 30)
PROFITABILITY
Objectives
VOLUME-BASED
Objectives
11
COMPETITIVE
Objectives
Profitability Objectives (P. 30)
12
• Realizing maximum profits in the business.
• Pricing objectives need to be measured precisely in order to be able to
assess performance
• Profitability objectives are measured and expressed in specific $ or %
•
$1.1 million for 3 years
• 10% increase in revenue before tax, etc.
13
Elements of Profitability (P. 30-31)
Monetary
sales mix
Qi
Pi
VCi
FC
Pi
= Price per unit of each product or service offering.
VCi
= Variable costs per unit of each offering.
FC
= Fixed costs per period.
Qi
= Volume produced and sold of each offering.
Monetary sales mix of the offering sold.
14
Profit Maximization (P. 31)
Low prices
High prices
Low unit profit margins
High unit profit margins
High unit sales
Low unit sales
High inventory turnover
Low inventory turnover
Depending on the marketing situation, maximum profits over a planning period
may be obtained by either pricing the firm’s offerings relatively low or relatively high.
Which pricing strategy to follow if you want to maximize profit?
Depending on the nature of market demand and competition.
Target Return on Investment (P. 31)
WHAT DO THEY INVEST ON ?
Wholesalers
& Retailers
Manufacturers
• Inventory
• Capital
• Buildings
• Machinery
• Buildings
• Land
• Inventory
15
• The ratio of profits to investments
• An ROI objective can be expressed
as a specific % of the investment
• A variation is target return on sales
Example
A firm with $10 million in capital
assets, seeking a 15% ROI, would
seek to achieve net contribution to
profits of___________for
the
$1.5 million
planning period.
Volume-Based Objectives (P. 32)
Sales Volume
• Revenue (sales) growth - prices are set
to
demand and unit sales.
• Market share - prices are set to sales
faster than competition; or to
a sales decline
to be slower than competition.
Customer
Demand
Creation
16
Competitive Objectives (P. 32)
17
Price stability - as a market leader,
the firm attempts to keep prices from declining
(usually found in mature markets);
usually leads to non-price competition.
Aggressive pricing - price below competition
to take advantage of market changes,
when market demand is growing,
or when opportunities to grow market share.
Establishing Relevant Pricing Objectives (P. 33-34)
Profitability Objectives
The firm is the low-cost supplier
The firm is the price leader
Volume-Based Objectives
The firm is low-cost supplier
The market is price sensitive
There is an internal required rate of
return for new product introductions
Cost decline as volume increases
There is a short lead time for new
products before competitors will likely to
enter the market.
There is a strong “captive” aftermarket
for replacement supplies
There is a growth market segment
There is little differential perceived value
in the offerings of firms in the market
To limit competitive entry
18
Competition Objectives
The firm is the low-cost supplier
There are no perceived value
differences across sellers in the minds
of buyers
Market share could be captured using
non-price marketing efforts
Summary (P. 34)
19
• There is no one apparent pricing objective for a specific set of market conditions.
• A profitability objective does not specify either a high- or low- price strategy.
• Using low price to pursue a volume objective must be viewed as an investment
over several years.
• The significance of being the low-cost supplier is …
• it allows the firm to invest in non-price marketing efforts.
• it is not a license to use price as a key competitive tool.
Seat Work 1 (P. 35)
Read the case given at Box 2.1 and answer the questions carefully.
1.What was Boeing Pricing Objective in the beginning of the case?
2. What was the result of their change in pricing objective?
3. How did they resolve the losses incurred to Boeing in 1997?
4. What is Boeing’s current pricing objective?
20
Market Structure : Degree of Competition
(P. 35)
21
Depending on the structure of competitors within a market, firms may have
considerable discretion to determine prices. Table 2.1 Characteristics of Market Structure
• Perfect (Pure) Monopoly
• Perfect (Pure) Competition
• Imperfect Competition
− Monopolistic Competition
− Oligopoly
Market Structure : Degree of Competition
(P. 36)
22
Perfect Monopoly ตลาดผูกขาดแท้จริง
• Only one seller supplies the product or service
• Considerable degree of power over price/Government regulations
Market Structure : Degree of Competition
(P. 36)
23
Perfect Competition ตลาดแข่งขันสมบูรณ์
• Many sellers offer many buyers an identical (homogeneous) product;
no seller can influence price
Market Structure : Degree of Competition
(P. 36)
24
Imperfect Competition ตลาดแข่งขันไม่สมบูรณ์
• Large number of sellers and buyers
• Few sellers, some sellers may hold relatively
large market shares and thus be able to influence the prices
of products they sell.
• Monopolistic Competition
• Oligopoly
Year 2008
Market Structure : Degree of Competition
(P. 37)
25
Monopolistic Competition ตลาดกึง่ แข่งขัน กึง่ ผูกขาด
• Large number of firms market heterogeneous (dissimilar) products
• The greater the degree of product differentiation perceived by buyers,
the greater is the opportunity for competing firms to set different prices
Market Structure : Degree of Competition
(P. 37)
26
Oligopoly ตลาดผูข้ ายน้อยราย
• Few sellers dominate the marketplace and thus have substantial influence
over price.
• The greater the degree of product differentiation perceived by buyers,
the greater is the opportunity for competing firms to set different prices
The Laws of Supply and Demand
(P. 38)
27
Whether one, a few, or many sellers are operating
in marketplace, their pricing decisions are influenced
to some degree by the economic laws affecting
supply and demand.
The Laws of Demand (P. 38)
28
• Demand is a relation among various amounts of a product that buyers
would be willing and able to purchase at possible alternative prices during
a given time, all other things remaining the same
• If supply is held constant…
• an increase in demand leads to and increased market price,
• a decrease in demand leads to a decreased market price.
Demand
Factors Affecting Laws of Demand
• Price
• Income of households
• Price and availability of substitute goods
• Price and availability of complement goods
• Expectations about future prices
• The size and composition of the population
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The Laws of Supply (P. 38)
30
• Supply is a relation showing the various amounts of a product that a seller would
make available for sale at possible alternative prices during a given period of
time, all other things remaining the same
• When the price of a good is raised, more will be produced
• If demand is held constant…
• an increase in supply leads to a decreased in price.
• a decrease in supply leads to an increased price.
Supply
Equilibrium (P. 39)
31
• In well-behaved markets, the supply and demand curves will intersect at
some point.
• An equilibrium between supply and demand is established, producing an
equilibrium price
• The market price at which the supply of an item equals the quantity
demanded.
P
Equilibrium Price
Q
Price Elasticity of Demand
(P. 43)
32
Price elasticity of demand measures the responsiveness of the quantity demanded
for a product or service to a change in the price of the product or service
(Q1  Q2) / Q1  Q / Q1
Ed 

 % Q  % P
( P1  P2) / P1  P / P1
Ed
ΔQ
ΔP
Q1, P1
= price elasticity of demand
= quantity change in demand
= quantity change in demand
= original quantity demanded and price, respectively
Income Elasticity of Demand (P. 44)
33
• Income elasticity of demand: responsiveness of the quantity demanded
of a product or service to a change in personal income
(  Q) ( I )
EI 

I
Q
• If EI is negative, the product is an inferior good
 Income goes up fewer units are demanded (switch to steak, less hamburger)
• If EI is positive, the product is a normal good
 Demand increases as income increases
• If 0<EI<1, the product becomes less important in households’ consumption plan
• If EI >1, the product becomes more important as income increases.
Cross-Price Elasticity of Demand (P. 45)
• Cross price elasticity of demand: responsiveness of demand for a
product to a change in the price of another product
QA PB
Ec 

PB QA
• If EC is negative, the two products are complementary
• If EC is positive, the two products are substitutes
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Consumers’ Surplus (P. 50)
35
• The difference between the maximum amount consumers are willing to
pay for a product (known as the reservation price) and the amount they
actually pay
Sellers’ Surplus (P. 51)
•The seller also enjoys a sellers' surplus, which we may define as the
difference between his minimum price and the market price.
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END OF CHAPTER II