(56)---THE OPTIMUM PRICING MODEL.

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

Where

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 demandA=(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.
  
  

(55)---FACTORS INFLUENCING THE PRICING DECISION.

Factors influencing the pricing decision

Markets.

The price that an organization can charge for its products will be determined to a greater or lesser degree by the market in which it operates. Here are some familiar terms that might feature as background for a question or that you might want to use in a written answer.
• Perfect competition-Many buyers and many sellers all dealing in an identical product. Neither producer nor user has any market power and both must accept the prevailing market price.
• Monopoly-One seller who dominates many buyers. The monopolists can use his market power to set a profit-maximizing price.
• Monopolistic competition-A large number of suppliers offer similar, but not identical products. The similarities ensure elastic demand whereas the slight differences give some monopolistic power to the supplier.
• Oligopoly-Where are relatively few competitive companies dominate the market whilst each large firm has the ability to influence market prices the unpredictable reaction from the other giants makes the final industry price in determinate. Cartels are often formed.

Other Factors

1. Prices Sensitivity.
2. Price Perception.
3. Compatibility with other Products.
4. Competitors.
5. Competition from substitute products.
6. Suppliers.

EXPLANATION/EXAMPLE.
Inflation-
in periods of inflation the organization may need to change prices to reflect increases in the prices of supplies and so on. Such changes may be needed to keep relative (real) prices unchanged.

Quality -
in the absence of other information, customers tend to judge quality by price. Thus a price change may send signals to customers concerning the quality of the product. A price rise may indicate improvements in quality, a price reduction may signal reduced quality, for example through the use of inferior components.

Incomes-
in times of rising incomes, price may become a less important marketing variable compared with product quality and convenience of access (distribution). When income levels are falling and /or unemployment levels rising, price will become a much more important marketing variable.

Ethics -
ethical considerations are a further factor, for example whether or not to exploit short-term shortages through higher prices.

CompetitionIf a rival cuts its prices in the expectation of increasing its market share, a firm has several options.

• It will maintain its existing prices if the expectation is that only a small market share would be lost, so that it is more profitable to keep prices at their existing level. Eventually, the rival firm may drop out of the market or be forced to raise its prices.
• It may maintain its prices but respond with a non-price counter-attack. This is a more-positive response, because the firms will besecuringor justifying its current prices with a product change, advertising, or better back-up services.
• It may reduce its prices. This should protect the firm’s market share so that the main beneficiary from the price reduction will be the consumer.
• It may raise its prices and respond with a non-price counter-attack.the extra revenue from the higher prices might be used to finance an advertising campaign or product design changes. A price increase would be based on a campaign to emphasize the quality difference between the firm’s own product and the rival’s product.