Tuesday, June 9, 2009


The optimum pricing model

Profit analysis.
  • Micro economic theory suggests that as output increases, the marginal cost (MC) per unit might rise (due to the low of diminishing returns) and whenever the firm is faced with a downward sloping demand curve, the marginal revenue (MR) per unit will decline.
  • Eventually, a level of output will be reached where the extra cost of marking one extra unit of output is greater than the extra revenue obtained from its sale. It would then be unprofitable to make and sell that extra unit
  • Profits will continue to be maximized only up to the output level where (MC) has risen to be exactly equal to MR.
  • Profit are maximized at the point where MC = MR, at a volume of Qn units.
  • If we add a demand or average revenue curve to the graph we can see that an output level of Qn, the sales price per unit would be P n.

    Deriving demand curve
  • When there is a linear relationship between demand and price, the equation for the demand curve is
P = a – BQ / Q

p = the price
Q = the quantity demanded
A = the price at which demand would be nil
B = the amount by which the price changes for each stepped change in demand

Q = the stepped change in demand
A=(current price)+(current quantity at current price/charge in quantity when price in charged by$)X$BThe demand function above shows how price (P) varies with quantity (Q).Alternatively you can always rearrange the equation to show how the quantity sold varies with the price charged.

Optimum pricing in practice .

The approach of optimal pricing with its prediction of a single predictable equilibrium price is important in economics. However in practice organizations rarely use the technique. The problems in applying optimal pricing occur for the following reasons.
  • It assumes that the demand curve and total costs can be identified with certainty. This is unlikely to be so.
  • It ignores the market research costs associated with acquiring knowledge of demand.
  • It assumes the firm has no productive constraint which could mean that the equilibrium point between supply and demand cannot be reached.
  • It assumes that the organization wishes to maximize profits. In fact it may have other objectives.
  • It assumes that price is the only influence on quantity demanded . we have seen that this is for from the case.

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