economics unit1

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UnitI

ENGG ECONOMICS & MANAGEMENT

Economics is the science that deals with the production and consumption of goods &services for human welfare.

The following are the economics goals:

o High level of employmento Price stabilityo Efficiencyo Distribution of incomeo Growth.

Engineering Economics

Deals with the methods that enable one to take economics decision towards minimizing

costs and maximizing benefits to business organization.

Significance of economics

Problem of scarcity & choice Allocation of resources What to produce How to produce For whom to produce Income distributions

TYPES OF EFFICIENCY & THEIR IMPACT ON OPERATION OF BUSINESS:

Efficiency is defined as the ratio of its output to input.

TECHNICAL ECONOMIC


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Technical efficiency:

Ratio of output to input of a physical system. Physical system may be diesel engine, machine

working on a floor.

Eg: Technical efficiency of a diesel engine :

Technical efficiency (%) = Heat equivalent of mechanical energy produced

--------------------------------------------------------------- *100

Heat equivalent of fuel used

It can never be more than 100%. Due to frictional loss and incomplete combustion of fuel which

is unavoidable in the working of diesel engine.

Economic efficiency:

Worth is the annual revenue generated by way of operating the business.

Cost is the total annual expenses incurred in carrying out the business

For survival and growth of the business, the economic efficiency should be more than 100%. It is

also called productivity.

DEMAND: One of the basic objective of the firm is to make profit No firm can survey without profit A firm can make profit only when goods produced by them are been demanded or when

the firm is able to create demand for its goods

Definition:

Demand for a commodity refers to

Desire on the part of the buyer to buy Willingness to pay for it Ability to the pay the specific price for it

Unless these 3 conditions are fulfilled the product is not set to have any demand

Example: If a person wants a car and cannot pay for it, there is no demand.

If a person need a car & not available in the market, it is said to be demand


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Types of Demand:

PRICE: - Refers to the quantity of a particular products or services demanded ata given price

INCOME:- Refers to the quantity of a particular products or services demandedat a given level of income of consumer

CROSS:- Refers to the quantity of a particular products or services, given at theprice of related goods

NOTE:

Related Goods refers to complementary or substitute,

Complementary goods ex: tier and tubes. One cannot go without other

Substitute goods ex: tea and coffee, take one and you can leave the other.

FACTORS DETERMINE DEMAND:

Price of the products:The basic demand relationship is between potential prices of a good and

the quantities that would be purchased at those prices. Generally the relationship

is negative meaning that an increase in price will induce a decrease in the quantity

demanded. This negative relationship is embodied in the downward slope of the

consumer demand curve. The assumption of a negative relationship is reasonable

and intuitive.

Income level of consumer:More the people earn the more they will spend and thus the demand will

rise. A fall in income will see a fall in demand.

Taste and preference of consumer:The greater the desire to own a good the more likely you is to buy the

good. There is a basic distinction between desire and demand. Desire is a measure

of the willingness to buy a good based on its intrinsic qualities. Demand is the


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willingness and ability to put one's desires into effect. It is assumed that tastes and

preferences are relatively constant.

Price of related goods:The principal related goods are complements and substitutes.

A complement is a good that is used with the primary good. Examples include

hotdogs and mustard, automobiles and gasoline. (Perfect complements behave as

a single good.) If the price of the complement goes up the quantity demanded of

the other good goes down.]Mathematically, the variable representing the price of

the complementary good would have a negative coefficient in the demand

function.

The other main category of related goods is substitutes. Substitutes are goods that

can be used in place of the primary good. The mathematical relationship between

the price of the substitute and the demand for the good in question is positive. If

the price of the substitute goes down the demand for the good in question goes

down.

Expectation above the price in future:If a consumer believes that the price of the good will be higher in the

future he is more likely to purchase the good now. If the consumer expects that

her income will be higher in the future the consumer may buy the good now. In

other words positive expectations about future income may encourage present

consumption.

Size of population:It is the number of people in a household. As the number of people

increases, the consumption will also increase. It will lead to increased demand.
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Nature of demand:

Individual demand Vs market demand:

The product buy an individual at a given level of price is called individual demand. The demand for a product by all buyers in a market is called market demand.

Autonomous demand Vs derived demand:

It refers to the direct demand fro products and services. The demand of this product does not depend up on the demand of other products Derived demand refers to the demand fro a product arises out of the purchase of a parent

product.

Eg: If there is no demand fro houses , there may be no demand fro steel, bricks, cementetc. A demand for houses is autonomous whereas a demand for these inputs is derived.

Durable Vs perishable goods:

Durable goods are those goods that give service for a relatively long period. Eg: Rice,wheat etc.

The life of perishable goods is very small a few hours or days. Eg : Milk, vegetablesetc.

Products such as T.V, refrigerator and washing machines are useful for a longer periodand hence are classified as consumer durables.

Firm demand Vs Industry demand :

Industry refers to the group of firms carrying on asimilar activity. The quantity of goods demanded by a single firm is called firm demand and the quantity

demanded by the industry as a whole is called industry demand.

Eg: A construction company may use 100 tonnes of cement during a given month. This isfirm demand. The construction industry in a particular state may have used 10 million

tones. This is industry demand.


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Total market Vs market segment:

Total market refers to the total demand for the product whereas segment implies a part ofit.

Ex: The total demand for sugar in the region is the total market demand. The demand forsugar from the sweet industry from this region is the segment market demand.

Exceptions to the law of demand are :

1. Giffen goods or Inferior goods.2. Prestige goods3. Speculation4. Price Illusion

These different types of exceptions are described in brief explanation as follows:-

Inferior goods :

Some goods like potato, bread, vegetable oil etc. are called inferior goods. In the case of

these goods when their price falls, the real income or the purchasing power of the consumer

increases, thispurchasing power is used to buy other superior goods. Such inferior goods are

named as 'Giffen goods'. An Irish economist Sir Robert Giffen observed this tendency of the

individuals in the 19th century.

Expectations and speculations:

When people expect a rise or fall in price in the near future, the law of demand does not

hold good. If a price rise is expected by next week, then they will buy more now itself though at

present the prices are quite high.

Prestige Goods:

Rich people like to show off their economic status. SO they buy prestige goods like

colour T.V., diamond etc. even at a higher price.
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Price illusion:

There are certain consumers those who are always guided by the price of the commodity.

They always believe that higher the price, better the quality. Hence they purchase larger

quantities of high priced goods.

Demonstration effect:

It refers to a tendency of low income groups to imitate the consumption pattern of high

income groups. They will buy a commodity to imitate the consumption of their neighbors even if

they don't have the purchasing power.

Ignorance:Sometimes due to ignorance of existing market price, and people buy more at a higher

price.

Quality and branded goods:

Commodities of good standard and quality give proper value for money. They last long

and give good service. So people prefer to buy them even at a higher price.

In the above exceptional cases, the demand graph curve slopes upward showing a positive

relationship between price and demand.

SUPPLY:

The total amount of a product (good or service) available forpurchase at any specified

price.

FACTORS INFLUENCE SUPPLY:

The price of the good or service:A rise in price will result in more of the commodity being supplied to the market

and vice versa.
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The price of other products:Any change in the prices of other products would influence the supply of a

product by substituting one product for another. If the market price of coffee rises, it

causes a reduction of the production and supply of tea as the producers withdraw some

resources from the production of tea and devote them for the production of wheat.

The state of technology:A change in technology leads to a fall in the cost of production. If the

technologies followed by the firms are improved, the cost of production will decline so

that the firms would supply more than before. Thus the improvement in technology leads

to an increase in the supply of a commodity.

Changes in the cost of factors of production:Supply depends on the cost of production. A rise in the cost of production will

shift the supply curve upward showing the decrees in the supply. On the other hand a fall

in the cost leads to an increase in the supply. In such a case the supply curve shifts tumid.

Climatic and seasonal influences:Climate and weather conditions affect the supply of commodities especially

agricultural goods.

The Law of Supply:

The law of supply states that as the price of a certain product rises, producers will supply

more of that product.

The law of supply holds that other things equal, as the price of a good rises, its quantitysupplied will rise, and vice versa.


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Supply Curve:

EXCEPTIONS TO LAW OF SUPPLY:

While the law of supply generally reflects what happens on the supply side of market, it

is not a universal principle that applies to all markets under all circumstances. There are, in fact,

numerous important exceptions to the law of supply. In particular, if the supply side of the

market is controlled by small number of sellers (including a single seller), then the law of supply

might not operate.

For example, monopoly, which is a market with a single seller, is not necessarily inclined to

offer a larger quantity supplied even though the price is higher. Market control by the monopoly

allows it to set the market price based on demand conditions, without cost constraints imposed

from the supply side. Other market structures, including oligopoly and monopolistic competition,

might have more competition, but market control can also negate the law of supply.


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DEMAND AND SUPPLY CURVE :

Break-Even Analysis

Meaning:

Break-even analysis is a study of costs, revenues and sales of a firm and finding out the

volume of sales where the firms costs and revenues will be equal. The object of break-even

analysis is not merely to spot the Break-even point, but to create an understanding about the

relationship between costs, revenues and output that could be sold within the competence of the

firm. It is also known as CVP ( Cost,Volume,Profit)analysis. This analysis is an important

bridge between business behavior and the theory of the firm. Break even Analysis is useful for

business executives, but also for an entrepreneur who is on the threshold of setting up his own

unit.

Fixed costs are costs that must be paid whether or not any units are produced. These costs are

"fixed" over a specified period of time or range of production.

Variable costs are costs that vary directly with the number of products produced. For instance,

the cost of the materials needed and the labour used to produce units isn't always the same.


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Determination of Break-Even Point (BEP)

Break even point is that level of sales where the net income is equal to zero. The break-even

point is the zone of no-profit and no-loss as the costs equal revenues. According to this

definition, at break even pointsales are equal tofixed costplusvariable cost

Key terms:

Selling price = Fixed cost+ Variable cost+ Profit

Profit = Selling price( Fixed cost+ Variable cost)

BEP can be determined in 2 ways:

(i) Determination of BEP in units:

Total Fixed Cost

The Break-Even Point quantity =

Contribution per unit

(Where, Contribution per unit = Selling price per unit - variable cost per unit)

(ii) Determination of BEP in Sales ValueTotal Fixed Cost

The Break-Even Point sales value =

Contribution Ratio

Where, Selling priceVariable cost

Contribution Ratio = -------------------------------------

Selling Price

Total cost = ( number of units at BEP) X (selling price per unit)

Therefore, Total Revenue = Total cost. This implies the BEP.
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BEP Chart:

Benefits / Advantages of Break Even Analysis:

The main advantages of break even point analysis is that it explains the relationship between

cost, production, volume and returns. It can be extended to show how changes in fixed cost,

variable cost, commodity prices, revenues will effect profit levels and break even points. Break

even analysis is most useful when used with partial budgeting, capital budgeting techniques. The

major benefits to use break even analysis is that it indicates the lowest amount of business

activity necessary to prevent losses.

Assumption of Break Even Analysis:

The Break-even Analysis depends on three key assumptions:

1. Average perunit sales price (per-unit revenue):This is the price that you receive per unit of sales. Take into account sales discounts and

special offers. Get this number from your Sales Forecast. For non-unit based businesses,


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make the per-unit revenue $1 and enter your costs as a percent of a dollar. The most common

questions about this input relate to averaging many different products into a single estimate.

The analysis requires a single number, and if you build your Sales Forecast first, then you

will have this number. You are not alone in this, the vast majority of businesses sell more

than one item, and have to average for their Breakeven analysis.

2. Average per-unit cost:This is the incremental cost, or variable cost, of each unit of sales. If you buy

goods for resale, this is what you paid, on average, for the goods you sell. If you sell a

service, this is what it costs you, per dollar of revenue or unit of service delivered, to

deliver that service. If you are using a Units-Based Sales Forecast table (for

manufacturing and mixed business types), you can project unit costs from the Sales

Forecast table. If you are using the basic Sales Forecast table for retail, service and

distribution businesses, use a percentage estimate, e.g., a retail store running a 50%

margin would have a per-unit cost of .5, and a per-unit revenue of 1.

3. Monthly fixed costs:Technically, a break-even analysis defines fixed costs as costs that would

continue even if you went broke. Instead, we recommend that you use your regular

running fixed costs, including payroll and normal expenses (total monthly Operating

Expenses). This will give you a better insight on financial realities. If averaging and

estimating is difficult, use your Profit and Loss table to calculate a working fixed cost

estimateit will be a rough estimate, but it will provide a useful input for a conservative

Break-even Analysis.

Limitations of Break Even Analysis:

It is best suited to the analysis of one product at a time. It may be difficult to classify a

cost as all variable or all fixed; and there may be a tendency to continue to use a break even

analysis after the cost and income functions have changed.


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Application of BEP:

It is used for decision making in various areas as follows:

1. Pricing decisions2. Make or buy decisions3. Products mix4. Utilization of limiting factors5. Alternative method of production6. Discontinuance of product line7. Expansion of capacity8. Product planning.

Pricing Policies

Meaning:

Price,the amount of money that has to be paid to acquire a given product. Insofar as the amount

people are prepared to pay for a product represents its value, price is also a measure of value.

Pricing is a Method adopted by a firm to set its selling price. It usually depends on the firm's

average costs, and on the customer's perceived value of the product in comparison to his or her

perceived value of the competing products. Different pricing methodsplace varying degree of

emphasis on selection, estimation, and evaluation ofcosts, comparative analysis, and market

situation.

Pricing objectives:

Pricing objectives or goals give direction to the whole pricingprocess.

Primary objectives:

1) The overall financial, marketing, and strategic objectives of the company;2) The objectives of the product or brand;3) Consumerprice elasticity and price points; and4) The availability of the resources
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Secondary objectives:

1) Maximize long-run profit2) maximize short-run profit3) increase sales volume (quantity)4) increase monetary sales5) increase market share6) obtain a target rate ofreturn on investment (ROI)7) obtain a target rate of return on sales8) Stabilize market or stabilize market price: an objective to stabilize price means that the

marketing manager attempts to keep prices stable in the marketplace and to compete on

non-price considerations. Stabilization of margin is basically a cost-plus approach inwhich the manager attempts to maintain the same margin regardless of changes in cost.

9) company growth10) maintain price leadership11) desensitize customers to price12) discourage new entrants into the industry13) match competitors prices14) encourage the exit of marginal firms from the industry15) survival16) avoid government investigation or intervention17) obtain or maintain the loyalty and enthusiasm ofdistributors and other sales personnel18) enhance the image of the firm, brand, orproduct19)be perceived as fair by customers and potential customers20) create interest and excitement about a product21) discourage competitors from cutting prices22) use price to make the product visible"23)build store traffic24) help prepare for the sale of the business (harvesting)25) social, ethical, or ideological objectives26) get competitive advantage
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Factors influencing price:

The price for a product may be influenced by many factors which can be categorized into two

main groups

1. Internal factors

2. External factors

Internal Factors - When setting price, marketers must take into consideration several factorswhich are the result of company decisions and actions. To a large extent these factors are

controllable by the company and, if necessary, can be altered. However, while the organization

may have control over these factors making a quick change is not always realistic. For instance,

product pricing may depend heavily on the productivity of a manufacturing facility (e.g., how

much can be produced within a certain period of time). The marketer knows that increasing

productivity can reduce the cost of producing each product and thus allow the marketer to

potentially lower the products price. But increasing productivity may require major changes at


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the manufacturing facility that will take time (not to mention be costly) and will not translate into

lower price products for a considerable period of time.

External Factors - There are a number of influencing factors which are not controlled by thecompany but will impact pricing decisions. Understanding these factors requires the marketer

conduct research to monitor what is happening in each market the company serves since the

effect of these factors can vary by market.

Internal Factors

1. Marketing Objectives

Marketing decisions are guided by the overall objectives of the company. While we will discuss

this in more detail when we cover marketing strategy in a later tutorial, for now it is important to

understand that all marketing decisions, including price, work to help achieve company

objectives.

Corporate objectives can be wide-ranging and include different objectives for different

functional areas (e.g., objectives for production, human resources, etc). While pricing decisions

are influenced by many types of objectives set up for the marketing functional area, there are

four key objectives in which price plays a central role. In most situations only one of these

objectives will be followed, though the marketer may have different objectives for different

products. The four main marketing objectives affecting price include:

Return on Investment (ROI)A firm may set as a marketing objective the requirement that allproducts attain a certain percentage return on the organizations spending on marketing the

product. This level of return along with an estimate of sales will help determine appropriate

pricing levels needed to meet the ROI objective. Cash FlowFirms may seek to set prices at a level that will insure that sales revenue will at least

cover product production and marketing costs. This is most likely to occur with new products

where the organizational objectives allow a new product to simply meet its expenses while

efforts are made to establish the product in the market. This objective allows the marketer to

worry less about product profitability and instead directs energies to building a market for the

product.


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Market ShareThe pricing decision may be important when the firm has an objective of gaininga hold in a new market or retaining a certain percent of an existing market. For new products

under this objective the price is set artificially low in order to capture a sizeable portion of the

market and will be increased as the product becomes more accepted by the target market (we will

discuss this marketing strategy in further detail in our next tutorial). For existing products, firms

may use price decisions to insure they retain market share in instances where there is a high level

of market competition and competitors who are willing to compete on price.

Maximize ProfitsOlder products that appeal to a market that is no longer growing may have acompany objective requiring the price be set at a level that optimizes profits. This is often the

case when the marketer has little incentive to introduce improvements to the product (e.g.,

demand for product is declining) and will continue to sell the same product at a price premium

for as long as some in the market is willing to buy.

2. Marketing Strategy

Marketing strategy concerns the decisions marketers make to help the company satisfy its target

market and attain its business and marketing objectives. Price, of course, is one of the key

marketing mix decisions and since all marketing mix decisions must work together, the final

price will be impacted by how other marketing decisions are made. For instance, marketers

selling high quality products would be expected to price their products in a range that will add to

the perception of the product being at a high-level.

It should be noted that not all companies view price as a key selling feature. Some firms, for

example those seeking to be viewed as market leaders in product quality, will deemphasize price

and concentrate on a strategy that highlights non-price benefits (e.g., quality, durability, service,

etc.). Such non-price competition can help the company avoid potential price wars that often

break out between competitive firms that follow a market share objective and use price as a key

selling feature

3. Costs

For many for-profit companies, the starting point for setting a products price is to first determine

how much it will cost to get the product to their customers. Obviously, whatever price


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customers pay must exceed the cost of producing a good or delivering a service otherwise the

company will lose money.

When analyzing cost, the marketer will consider all costs needed to get the product to market

including those associated with production, marketing, distribution and company administration

(e.g., office expense). These costs can be divided into two main categories:

Fixed Costs - Also referred to as overhead costs, these represent costs the marketing organizationincurs that are not affected by level of production or sales. For example, for a manufacturer of

writing instruments that has just built a new production facility, whether they produce one pen or

one million they will still need to pay the monthly mortgage for the building. From the marketing

side, fixed costs may also exist in the form of expenditure for fielding a sales force, carrying out

an advertising campaign and paying a service to host the companys website. These costs are

fixed because there is a level of commitment to spending that is largely not affected by

production or sales levels.

Variable CostsThese costs are directly associated with the production and sales of productsand, consequently, may change as the level of production or sales changes. Typically variable

costs are evaluated on a per-unit basis since the cost is directly associated with individual items.

Most variable costs involve costs of items that are either components of the product (e.g., parts,

packaging) or are directly associated with creating the product (e.g., electricity to run an

assembly line). However, there are also marketing variable costs such as coupons, which are

likely to cost the company more as sales increase (i.e., customers using the coupon). Variable

costs, especially for tangible products, tend to decline as more units are produced. This is due to

the producing companys ability to purchase product components for lower prices since

component suppliers often provide discounted pricing for large quantity purchases.

Determining individual unit cost can be a complicated process. While variable costs are often

determined on a per-unit basis, applying fixed costs to individual products is less

straightforward. For example, if a company manufactures five different products in one

manufacturing plant how would it distribute the plants fixed costs (e.g., mortgage, production

workers cost) over the five products? In general, a company will assign fixed cost to individual

products if the company can clearly associate the cost with the product, such as assigning the


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Unitary DemandThis demand occurs when a percentage change in price results in an equal andopposite percentage change in demand. For example, if the price of a product increases

(decreases) by 10%, the demand for the product is likely to decline (rise) by 10%.

For marketers the important issue with elasticity of demand is to understand how it impacts

company revenue. In general the following scenarios apply to making price changes for a given

type of market demand:

For elastic marketsincreasing price lowers total revenue while decreasing price increases totalrevenue.

For inelastic marketsincreasing price raises total revenue while decreasing price lowers totalrevenue.

For unitary marketsthere is no change in revenue when price is changed.

2. Customer Expectations

Possibly the most obvious external factors that influence price settings are the expectations of

customers and channel partners. As we discussed, when it comes to making a purchase decision

customers assess the overall value of a product much more than they assess the price. When

deciding on a price marketers need to conduct customer research to determine what price

points are acceptable. Pricing beyond these price points could discourage customers from

purchasing.

Firms within the marketers channels of distribution also must be considered when determining

price. Distribution partners expect to receive financial compensation for their efforts, which

usually means they will receive a percentage of the final selling price. This percentage or margin

between what they pay the marketer to acquire the product and the price they charge their

customers must be sufficient for the distributor to cover their costs and also earn a desired profit.

3. Competitive and Other Products

Marketers will undoubtedly look to market competitors for indications of how price should be

set. For many marketers of consumer products researching competitive pricing is relatively easy,


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particularly when Internet search tools are used. Price analysis can be somewhat more

complicated for products sold to the business market since final price may be affected by a

number of factors including if competitors allow customers to negotiate their final price.

Analysis of competition will include pricing by direct competitors, related products and primary

products.

Direct Competitor PricingAlmost all marketing decisions, including pricing, will include anevaluation of competitors offerings. The impact of this information on the actual setting of price

will depend on the competitive nature of the market. For instance, products that dominate

markets and are viewed as market leaders may not be heavily influenced by competitor pricing

since they are in a commanding position to set prices as they see fit. On the other hand in

markets where a clear leader does not exist, the pricing of competitive products will be carefully

considered. Marketers must not only research competitive prices but must also pay close

attention to how these companies will respond to the marketers pricing decisions. For instance,

in highly competitive industries, such as gasoline or airline travel, competitors may respond

quickly to competitors price adjustments thus reducing the effect of such changes.

Related Product Pricing - Products that offer new ways for solving customer needs may look topricing of products that customers are currently using even though these other products may not

appear to be direct competitors. For example, a marketer of a new online golf instruction service

that allows customers to access golf instruction via their computer may look at prices charged by

local golf professionals for in-person instruction to gauge where to set their price. While on the

surface online golf instruction may not be a direct competitor to a golf instructor, marketers for

the online service can use the cost of in-person instruction as a reference point for setting price.

Primary Product Pricing - As we discussed in the Product Decisions tutorial, marketers may sellproducts viewed as complementary to a primary product. For example, Bluetooth headsets are

considered complementary to the primary product cell phones. The pricing of complementary

products may be affected by pricing changes made to the primary product since customers may

compare the price for complementary products based on the primary product price. For example,

companies that sell accessory products for the Apple iPod may do so at a cost that is only 10% of

the purchase price of the iPod. However, if Apple were to dramatically drop the price, for

instance by 50%, the accessory at its present price would now be 20% of the of iPod price. This
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may be perceived by the market as a doubling ofthe accessorys price. To maintain its perceived

value the accessory marketer may need to respond to the iPod price drop by also lowering the

price of the accessory.

4. Government Regulation

Marketers must be aware of regulations that impact how price is set in the markets in which their

products are sold. These regulations are primarily government enacted meaning that there may

be legal ramifications if the rules are not followed. Price regulations can come from any level of

government and vary widely in their requirements. For instance, in some industries, government

regulation may set price ceilings (how high price may be set) while in other industries there may

be price floors (how low price may be set). Additional areas of potential regulation include:

deceptive pricing, price discrimination, predatory pricing and price fixing.

Finally, when selling beyond their home market, marketers must recognize that local regulations

may make pricing decisions different for each market. This is particularly a concern when selling

to international markets where failure to consider regulations can lead to severe penalties.

Consequently marketers must have a clear understanding of regulations in each market they

serve.

Pricing Methods or Types Or Strategies

1. Cost plus pricing

The most common way for businesses to decide on a price. Add up the cost of the raw materials

and labor that have gone into making the product to determine its cost. Then add on an element

of profit over and above the cost mark up

2. Competitor based pricing

Firms have to charge similar prices to other firms. This happens when there is lots of choice and

not much product differentiation e.g. petrol, CDs.

3.Promotional pricing

Sales, Special offers,Final reductions,Buy one get one free!

Used to increase sales in the short term, in order to clear space for new lines, undercut a rival or


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clear stock that is no longer in demand.

4. Penetration pricing

Setting an initial low price - to get consumer interested. When this low price is below cost it is

called loss leading. Once established the price will increase.

Example - Collectors magazines

5.Price discrimination

Charging different prices to different consumers for the same product.

Example is rail/bus travel for students and OAPs

6.Skimming

Opposite to penetration pricing.

Firms charge a high price to begin with which helps to make the product desirable.

Once established firm will lower the price.

Example - digital TV, MP3 players

7. Limit pricing

A limit price is the price set by a monopolist to discourage economic entry into a market, and is

illegal in many countries. The limit price is the price that the entrant would face upon entering as

long as the incumbent firm did not decrease output. The limit price is often lower than the

average cost of production or just low enough to make entering not profitable. The quantity

produced by the incumbent firm to act as a deterrent to entry is usually larger than would be

optimal for a monopolist, but might still produce higher economic profits than would be earned

under perfect competition.

The problem with limit pricing as strategic behavior is that once the entrant has entered the

market, the quantity used as a threat to deter entry is no longer the incumbent firm's best

response. This means that for limit pricing to be an effective deterrent to entry, the threat must in

some way be made credible. A way to achieve this is for the incumbent firm to constrain itself to

produce a certain quantity whether entry occurs or not. An example of this would be if the firm

signed a union contract to employ a certain (high) level of labor for a long period of time.

8. Loss leader

A loss leader or leader is a product sold at a low price (at cost or below cost) to stimulate other

profitable sales.

8. Market-oriented pricing


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Setting a price based upon analysis and research compiled from the targeted market.

9. Premium pricing

Premium pricing is the practice of keeping the price of a product or service artificially high in

order to encourage favorable perceptions among buyers, based solely on the price. The practice

is intended to exploit the (not necessarily justifiable) tendency for buyers to assume that

expensive items enjoy an exceptional reputation or represent exceptional quality and distinction.

10. Predatory pricing

Aggressive pricing intended to drive out competitors from a market. It is illegal in some places.

11. Contribution margin-based pricing

Contribution margin-based pricing maximizes the profit derived from an individual product,

based on the difference between the product's price and variable costs (the product's contribution

margin per unit), and on ones assumptions regarding the relationship between the products

price and the number of units that can be sold at that price. The product's contribution to total

firm profit (i.e., to operating income) is maximized when a price is chosen that maximizes the

following: (contribution margin per unit)X(number of units sold)...

12. Psychological pricing

Pricing designed to have a positive psychological impact. For example, selling a product at $3.95

or $3.99, rather than $4.00.

13. Dynamic pricingA flexible pricing mechanism made possible by advances in information technology, and

employed mostly by Internet based companies. By responding to market fluctuations or large

amounts of data gathered from customers - ranging from where they live to what they buy to

how much they have spent on past purchases - dynamic pricing allows online companies to

adjust the prices of identical goods to correspond to a customers willingness to pay. The airline

industry is often cited as a dynamic pricing success story. In fact, it employs the technique so

artfully that most of the passengers on any given airplane have paid different ticket prices for the

same flight.

14. Price leadership

An observation made of oligopic business behavior in which one company, usually the dominant

competitor among several, leads the way in determining prices, the others soon following. 15.

15.Target pricing


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Pricing method whereby the selling price of a product is calculated to produce a particular rate of

return on investment for a specific volume of production. The target pricing method is used most

often by public utilities, like electric and gas companies, and companies whose capital

investment is high, like automobile manufacturers.

Target pricing is not useful for companies whose capital investment is low because, according to

this formula, the selling price will be understated. Also the target pricing method is not keyed to

the demand for the product, and if the entire volume is not sold, a company might sustain an

overall budgetary loss on the product.

16. Absorption pricing

Method of pricing in which all costs are recovered. The price of the product includes the variable

cost of each item plus a proportionate amount of the fixed costs. A form of cost plus pricing

17. High-low pricing

Method of pricing for an organization where the goods or services offered by the organization

are regularly priced higher than competitors, but through promotions, advertisements, and or

coupons, lower prices are offered on key items. The lower promotional prices are targeted to

bring customers to the organization where the customer is offered the promotional product as

well as the regular higher priced products.

18. Premium Decoy pricing

Method of pricing where an organization artificially sets one product price high, in order to boost

sales of a lower priced product.

19. Marginal-cost pricing

In business, the practice of setting the price of a product to equal the extra cost of producing an

extra unit of output. By this policy, a producer charges, for each product unit sold, only the

addition to total cost resulting from materials and direct labor. Businesses often set prices close

to marginal cost during periods of poor sales. If, for example, an item has a marginal cost of

$1.00 and a normal selling price is $2.00, the firm selling the item might wish to lower the price

to $1.10 if demand has waned. The business would choose this approach because the incremental

profit of 10 cents from the transaction is better than no sale at all.

20. Value Based pricing

Pricing a product based on the perceived value and not on any other factor. Pricing based on the

demand for a specific product would have a likely change in the market place.
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Pricing strategy in times of stiff price competition:

1.Price Matching:

An excellent customer service feature being offered by many companies today is price matching.

Since companies know that both they and their competitors change thousands of prices every

week, it's impossible for them to know if they become underpriced on certain items--and thus

start losing sales. So they declare that they will match the prices of their competitors, in the

hopes that you will shop with them instead of their competition. Of course, often the competition

does the same thing.

2. Promoting brand loyalty:

This is an advertising strategy where customers are frequently reminded of brand value of given

product. Brand loyal customers continue to be with the firm despite its higher prices. Ex: Pepsi

and Coke.

3. Time to time pricing:

The firm varies its pricing from time to time, could be hour to hour or day to day. This method

offers two advantages. 1. The rival firm cannot play with price cuts. 2. Customers will have no

experience of which firm charges the lowest price .so all the firms have their own undistributed

market share.

4. Promotional Pricing:

Sales, special offers. Final reductions. Buy one get one free. Used to increase sales in the short

term, inorder to clear space fro new lines, undercut a rival or clear stock that is no longer in

demand.

5.Target Pricing:

Pricing method whereby the selling price of a product is calculated to produce a particular rate of

return on investment for a specific volume of production. The target pricing method is used most

often by public utilities, like electric and gas companies, and companies whose capital

investment is high, like automobile manufacturers.


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Target pricing is not useful for companies whose capital investment is low because, according to

this formula, the selling price will be understated. Also the target pricing method is not keyed to

the demand for the product, and if the entire volume is not sold, a company might sustain an

overall budgetary loss on the product.

economics unit1

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