Chapter 14: Increasing Revenue with Advanced Pricing Strategies
1. Substitute $6.00 for MC and –4.0 for η.
2. Calculate the value in the parentheses.
3. Multiply values to yield a price of $8.00.
Pricing Based upon Cost: Cost-Plus Pricing and Breakeven Analysis Two pricing policies you commonly encounter in business are cost-plus pricing and breakeven pricing. These policies are very simple pricing strategies based upon production costs. Simple doesn’t mean better or worse. The advantage of simple in these cases is that calculating price is easy. The disadvantage of these simple strategies is that they ignore demand. Thus, it’s important to understand under what circumstances these simple methods of price determination help you reach your goal of maximum profit.
Cost-plus pricing Cost-plus pricing means that you determine price by starting with the good’s cost and then adding a fixed percentage or amount to that cost. One of the primary reasons cost-plus pricing is so popular is its simplicity. Often information on marginal revenue and marginal cost is difficult to obtain with precision, making it impossible to exactly determine the point of profit maximization. By using cost-plus pricing, you can simply include a desired rate of return in the mark-up. Another advantage of cost-plus pricing is its desirability from the standpoint of public relations. This pricing technique provides an obvious rationale for price increases when cost increases occur. Cost-plus pricing typically involves two steps. First, the firm determines the per unit cost or average total cost of producing the good. Because average total cost varies as the quantity of output produced changes, the firm’s determination of per unit cost requires the specification of an output level. After the firm establishes the per unit cost, the firm adds a mark-up to the per unit cost. The mark-up is typically in the form of a percentage, and it represents costs that can’t be easily allocated to a specific product produced by the firm plus a return on the firm’s investment.
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