Presentation on theme: "CH 2 The Economics of Price Determination"— Presentation transcript:
1 CH 2 The Economics of Price Determination Kent B. Monroe (2007). Pricing: Making Profitable Decisions.3rd Edition (Singapore: McGraw-Hill) .
2 02 Chapter Objectives (P.26) To summarize the traditional neoclassical economic theory of price determinationTo introduce some useful concepts for actual pricing decisions such as revenue, elasticity, marginal revenue, marginal costs etc.
3 03 Price Determination Theory (P.26-27) Minimize input cost The firmMinimize input costMaximize profitEconomic theory is more concerned with the behaviorof aggregates or markets, particularly how persistentand widespread behavior leads to stable results called“Equilibrium”.
4 04 Price Determination Theory (P.26-27) Economic Perspective The firm is a pricetaker, not the pricemakerManagement determines the quantity toproduceThe market sets price through the forces ofsupply and demandMarketing PerspectivePrice is a decision variable.
5 05 The Profit-Maximizing Firm (P. 28) Q1 Q* Q Fixed costs Revenues or Q1Q*QFixed costsRevenuesorCosts$UnitsTotal RevenueMaximum ProfitsTotal CostsPriceFigure 2.1 Output Determination for Profit-Maximizing Firm – Short Run(Constant Prices) : Aggregate Analysis
6 06 The Profit-Maximizing Firm (P. 28) Q* Q Costs $ Units Price Q*QCosts$UnitsPriceAverage costMarginal cost(Marginal revenue)Figure 2.2 Output Determination for Profit-Maximizing Firm – Short Run(Constant Prices) : Marginal Analysis
7 07 The Profit-Maximizing Firm (P. 29) Q* Q Price $ Units Demand Q*QPrice$UnitsDemandMarginal cost(Marginal revenue)P*Figure 2.3 Output Determination for Profit-Maximizing Firm – Short Run(Varying Prices)
8 08 Challenges to the Profit Maximization Obj.(P. 29) Profits are not the only objective of managers of the firm.The actual objectives of the organization are determined by a wide range of …personal objectivespressuresconstraints from the external environmentThe goal of some managers may be to simply attain satisfactory profits.
9 10 Corporate and Pricing Objective (P. 30) Pricing objectives should beconsistent with & should advancecorporate & marketing objectivesOverall corporate objectivesmust be considered.The organization’s specific marketing objectives are based on those corporate objectives.Setting objectives for one element of the marketing mix.
11 12 Profitability Objectives (P. 30) Realizing maximum profits in the business.Pricing objectives need to be measured precisely in order to be able to assess performanceProfitability objectives are measured and expressed in specific $ or %$1.1 million for 3 years10% increase in revenue before tax, etc.
12 13 Elements of Profitability (P. 30-31) PiVCiFCQiMonetarysales mixPi = Price per unit of each product or service offering.VCi = Variable costs per unit of each offering.FC = Fixed costs per period.Qi = Volume produced and sold of each offering.Monetary sales mix of the offering sold.
13 14 Profit Maximization (P. 31) Low pricesHigh pricesLow unit profit marginsHigh unit profit marginsHigh unit salesLow unit salesHigh inventory turnoverLow inventory turnoverDepending on the marketing situation, maximum profits over a planning periodmay be obtained by either pricing the firm’s offerings relatively low or relatively high.Which pricing strategy to follow if you want to maximize profit?Depending on the nature of market demand and competition.
14 15 Target Return on Investment (P. 31) WHAT DO THEY INVEST ON ? The ratio of profits to investmentsAn ROI objective can be expressedas a specific % of the investmentA variation is target return on salesWholesalers& RetailersInventoryBuildingsManufacturersCapitalMachineryBuildingsLandInventoryA firm with $10 million in capital assets, seeking a 15% ROI, would seek to achieve net contribution to profits of___________for the planning period.Example$1.5 million
15 16 Volume-Based Objectives (P. 32) Sales VolumeRevenue (sales) growth - prices are setto demand and unit sales.Market share - prices are set to salesfaster than competition; or to a sales declineto be slower than competition.CustomerDemandCreation
16 17 Competitive Objectives (P. 32) Price stability - as a market leader,the firm attempts to keep prices from declining(usually found in mature markets);usually leads to non-price competition.Aggressive pricing - price below competition to take advantage of market changes,when market demand is growing,or when opportunities to grow market share.
17 18 Establishing Relevant Pricing Objectives (P. 33-34) Profitability ObjectivesVolume-Based ObjectivesCompetition ObjectivesThe firm is the low-cost supplierThe firm is low-cost supplierThe firm is the price leaderThe market is price sensitiveThere are no perceived value differences across sellers in the minds of buyersThere is an internal required rate of return for new product introductionsCost decline as volume increasesMarket share could be captured using non-price marketing effortsThere is a short lead time for new products before competitors will likely to enter the market.There is a strong “captive” aftermarket for replacement suppliesThere is a growth market segmentThere is little differential perceived value in the offerings of firms in the marketTo limit competitive entry
18 19Summary (P. 34)There is no one apparent pricing objective for a specific set of market conditions.A profitability objective does not specify either a high- or low- price strategy.Using low price to pursue a volume objective must be viewed as an investment over several years.The significance of being the low-cost supplier is …it allows the firm to invest in non-price marketing efforts.it is not a license to use price as a key competitive tool.
19 20Seat Work 1 (P. 35)Read the case given at Box 2.1 and answer the questions carefully.What was Boeing Pricing Objective in the beginning of the case?2. What was the result of their change in pricing objective?3. How did they resolve the losses incurred to Boeing in 1997?4. What is Boeing’s current pricing objective?
20 21 Market Structure : Degree of Competition (P. 35) Depending on the structure of competitors within a market, firms may haveconsiderable discretion to determine prices.Table 2.1 Characteristics of Market StructurePerfect (Pure) MonopolyPerfect (Pure) CompetitionImperfect CompetitionMonopolistic CompetitionOligopoly
21 22 Market Structure : Degree of Competition (P. 36) Perfect Monopoly ตลาดผูกขาดแท้จริงOnly one seller supplies the product or serviceConsiderable degree of power over price/Government regulations
22 23 Market Structure : Degree of Competition (P. 36) Perfect Competition ตลาดแข่งขันสมบูรณ์Many sellers offer many buyers an identical (homogeneous) product;no seller can influence price
23 24 Market Structure : Degree of Competition (P. 36) Imperfect Competition ตลาดแข่งขันไม่สมบูรณ์Large number of sellers and buyersFew sellers, some sellers may hold relativelylarge market shares and thus be able to influence the pricesof products they sell.Monopolistic CompetitionOligopolyYear 2008
24 25 Market Structure : Degree of Competition (P. 37) Monopolistic Competition ตลาดกึ่งแข่งขัน กึ่งผูกขาดLarge number of firms market heterogeneous (dissimilar) productsThe greater the degree of product differentiation perceived by buyers,the greater is the opportunity for competing firms to set different prices
25 26 Market Structure : Degree of Competition (P. 37) Oligopoly ตลาดผู้ขายน้อยรายFew sellers dominate the marketplace and thus have substantial influenceover price.The greater the degree of product differentiation perceived by buyers,the greater is the opportunity for competing firms to set different prices
26 27 The Laws of Supply and Demand (P. 38) supply and demand. Whether one, a few, or many sellers are operatingin marketplace, their pricing decisions are influencedto some degree by the economic laws affectingsupply and demand.
27 28The Laws of Demand (P. 38)Demand is a relation among various amounts of a product that buyers would be willing and able to purchase at possible alternative prices during a given time, all other things remaining the sameIf supply is held constant…an increase in demand leads to and increased market price,a decrease in demand leads to a decreased market price.
28 29 Factors Affecting Laws of Demand Price Income of households Price and availability of substitute goodsPrice and availability of complement goodsExpectations about future pricesThe size and composition of the population
29 30The Laws of Supply (P. 38)Supply is a relation showing the various amounts of a product that a seller would make available for sale at possible alternative prices during a given period of time, all other things remaining the sameWhen the price of a good is raised, more will be producedIf demand is held constant…an increase in supply leads to a decreased in price.a decrease in supply leads to an increased price.
30 31Equilibrium (P. 39)In well-behaved markets, the supply and demand curves will intersect at some point.An equilibrium between supply and demand is established, producing an equilibrium priceThe market price at which the supply of an item equals the quantity demanded.
31 32 Price Elasticity of Demand (P. 43) ΔQ = quantity change in demand Price elasticity of demand measures the responsiveness of the quantity demanded for a product or service to a change in the price of the product or serviceEd = price elasticity of demandΔQ = quantity change in demandΔP = quantity change in demandQ1, P1 = original quantity demanded and price, respectively
32 33 Income Elasticity of Demand (P. 44) Income elasticity of demand: responsiveness of the quantity demanded of a product or service to a change in personal incomeIf EI is negative, the product is an inferior good Income goes up fewer units are demanded (switch to steak, less hamburger)If EI is positive, the product is a normal good Demand increases as income increasesIf 0<EI<1, the product becomes less important in households’ consumption planIf EI >1, the product becomes more important as income increases.
33 34 Cross-Price Elasticity of Demand (P. 45) Cross price elasticity of demand: responsiveness of demand for a product to a change in the price of another productIf EC is negative, the two products are complementaryIf EC is positive, the two products are substitutes
34 35 Consumers’ Surplus (P. 50) The difference between the maximum amount consumers are willing to pay for a product (known as the reservation price) and the amount they actually pay
35 36Sellers’ Surplus (P. 51)The seller also enjoys a sellers' surplus, which we may define as the difference between his minimum price and the market price.