Pricing Decisions Policies & Practices

Summary
Chapter Thirteen
Pricing Decisions, Policies and Practices
Introduction :
Price has direct impact on firms profits. Fixing
appropriate price is a major decision making
function of any enterprise. Price decisions,
therefore, are reviewed by the top management from
time to time.
Determinants of price of a commodity.
1. Cost
of
production.
Normally
prices
are
determined to cover the costs and allow profit
to the enterprise.
2. Demand for the product. Products
always command high prices.
in
demand
3. Elasticity of demand. Products with lesser

elasticity of demand are sold at higher prices
and vice versa.
4. Objective or the goal of the producer. If the
goal of the firm is sales maximization, or
earning goodwill of consumers, lower prices are
fixed.
5. Nature of competition in the market. Fierce

competition forces firms to fix prices most
aggressively. Under perfect competition price
is determined by the point of intersection of

supply & demand.
Producer is a price taker and not a price
maker. Under monopoly producer fixes price
through trial and error until his MR = MC. At
that point his profit is maximum and he is in
equilibrium.
Producer practicing price discrimination fixes
different price for each market depending on
elasticity of demand for his product in each
market.
Under monopolistic competition producers do not
have a price war, instead they
differentiate
their products to charge competitive prices.
Under oligopoly producers will have a price
war, or charge ( normally high ) prices by an
agreement with each other. Prices are normally
rigid in oligopoly.
6. Government policy pertaining to the product.
Firms need to comply with the pricing policies
of the Government.
Pricing Methods in Practice
1. Full Cost Pricing :Is also known as Cost Plus Pricing.
Price in this method is a sum of Average Variable
Cost, Average Fixed Cost and Net Profit Margin.
The method is attractive as price based on cost
appears reasonable. Plus the method is simple and
fair method of pricing.
However, it suffers from the following limitations:
It disregards demand.
Seller is not forced to control costs.
Method leads to over pricing in decreasing costs

situation or under pricing in rising costs
situation, as only historical costs considered in
this method.
Method is difficult to implement if variable
costs of the firm fluctuate frequently.
Forces of competition are totally ignored by the
method and there is a chance that the firm may be
wiped out of market.
2. Marginal Cost Pricing :In this method only variable costs are considered
and fixed costs are ignored. The method is very
useful in a short period. But in the long period,
fixed costs must be considered.
The
method
has
distinct
advantages
as
it
encourages aggressive pricing policy. The firm
encouraged to keep marginal cost under control to
offer low prices. Prices fixed under this method
are very competitive. The method is very useful
for a multi-product, multi-process or multimarket firm. Also is useful for pricing over the
life cycle of a product.
However the method cannot be used over a long
period as fixed costs are ignored. It is possible
that it may lead to frequent changes in price,
which is not appreciated by consumers. The method
leads to over pricing in decreasing costs or
under pricing in rising costs, as only historical
costs considered.
3. Multi Product Pricing :Firms producing more than one product, whether
variations, substitutes, complementary or of
totally different nature have to resort to multi
product pricing.
Availability of unutilized capacity has a major

impact in pricing multi- products.
If products are totally independent, pricing is
similar to single product pricing. But in case of
joint products, total cost must be recovered by
the pricing of both products together. In case of
substitutes, the degree of elasticity of demand
separates the markets. The multi product firm is
more like a discriminating monopolist fixing
prices of products based on elasticity of their
demand.
4. Pricing of a New Product :If the new product has many substitutes in the
market, competitive prices need to be fixed. If
the
product
is
entirely
new,
Skimming
or
Penetration pricing are alternatives available to
the producer.
In Skimming Price method, the firm charges
highest possible price that the consumer can
bear.
This
is
fortified
with
heavy
sales
promotion and advertising efforts. In penetration
price, lowest possible price is initially charged
to get into the market as early as possible.
Prices are raised as the firm establishes its
market share.
5. Pricing of Exports :Pricing of exports is complex when compared to
pricing in the local market. The nature of demand
in the foreign market can be very different.
Degrees of competition based on quality of the
product vary from country to country. Different
technologies employed by competing firms in other
countries have their effects on costs.
Pricing
has
to
consider
availability
of
substitutes in each overseas market. Governments
incentives have favourable effect on prices. On
the other hand, export regulations can restrict
pricing decisions. Regularity of demand is
another factor that has to be considered as it is
quite likely that current demand could be only
for a short period. Conditions for delivering
goods overseas have to be studied as they add to
the cost of product.
After considering above factors, firms adopt
these pricing strategies. Penetration pricing of
low prices is undertaken by firms to capture
foreign market. Firms also resort to Skimming
price for maximization of profit. It is common
practice to arrange Dumping - charging lower
export price, to enter exports. Competitive
pricing is required when there are many players.
Standard worldwide price that is based on average
cost of production can be fixed if producing
firms can work together. Dual pricing based on
cost plus or marginal costing is another useful
strategy. Some firms follow the leader in the
market and fix price which equals that charged by
a major market share holder. Probe pricing by
firms uses trial & error method.
A variety of approaches in setting prices.
1. Intuitive Pricing :
a psychological method.
Price is based on the feel of the market.
2. Experimental : or trial & error pricing.
3. Initiative Pricing: Firms follow price fixing
policy of the market leader.
4. Backward Cost Pricing: Price decided first,

then product designed to arrive at a suitable
cost that provides reasonable profit margin.
5. Odd number & Critical Number Pricing: Price is
always an odd or other number fancied by
consumers.
6. Double pricing: Two prices appear on the price
tag. The higher one is scored out making the
second price attractive to customers..
7. Prestige Pricing: Some sort of social scaling

exerts a powerful influence on the pricing
behaviour, as result higher prices are expected
to reflect higher quality.
8.
Multiple
Pricing
/
Collective
Pricing:
Offering more units for a ( higher ) price. This
replaces common method of indicating price per
single unit.
9. Peak Load Pricing : Changing prices to suit
Peak and off peak demand. Higher prices are
charged when demand is at a peak and they are
lowered once peak season is over.
Administered prices and Price control.
Administered prices
Prices were first administered by a monopolist
who fixed them irrespective of costs. In India,
administered prices are those prices which are
fixed and enforced by the Government. Prices are
fixed to prevent exploitation of consumers by
firms charging high prices to maximize their
profit. Providing stable and assured income to
farmers or other weaker sections of the Society

is another objective of price control. It is used
for discouraging or encouraging the consumption
of products by increasing prices of harmful
products or lowering prices of essentials.
Price Control
Price Control refers to a direct measure on the
part of the Government in fixing the prices for
achieving certain macro economic goals like
social welfare, efficient resource allocation,
prevention of exploitation of the consumers etc.
Informal price control results in producers
voluntarily agreeing to maintain prices at levels
suggested by the Government. Formal price control
enforces prices fixed by the Government on the
producers.
Total price control covers entire output of the
product e.g. drug prices. It is also known as
Mono Pricing. Partial price control covers a part
of the output that has to be sold at regulated
prices, usually through approved agencies to
selected group of customers. It is also known as
Dual Pricing
Price control for agricultural products, drugs,
cotton
and
other
essential
products,
is
administered by the Government, through various
Commissions, Boards, Bureaus appointed by it.

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Summary

3. Elasticity of demand. Products with lesser

5. Nature of competition in the market. Fierce

is determined by the point of intersection of

Method leads to over pricing in decreasing costs

Availability of unutilized capacity has a major

4. Backward Cost Pricing: Price decided first,

7. Prestige Pricing: Some sort of social scaling

farmers or other weaker sections of the Society

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