MT6003 Unit 2 Demand and Supply Analysis

1. Demand and Supply Analysis
ENGINEERING ECONOMICS
&
COST ANALYSIS
Demand and Supply Analysis
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B.K.Parrthipan, M.E, M.B.A.,
Assistant Professor / Mechatronics Engineering,
Kamaraj College of Engineering and Technology.

2. Cost
An amount that has to be paid or given up
in order to get something.
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3. Types of cost
1. Fixed Costs (FC)
The costs which does not vary with respect to
output. Fixed costs might include the cost of
building a factory, insurance and legal bills. Even if
your output changes or you don’t produceyour output changes or you don’t produce
anything, your fixed cost stays the same
2. Variable Costs (VC)
Costs which depend on the output produced.
For example, if you produce more cars, you have
to use more raw materials such as metal. This is a
variable cost.
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4. Types of cost
3. Total Costs (TC)
A total cost is the sum of fixed costs and
variable costs.
Total Costs (TC) = Fixed costs (FC) + Variable
Costs (VC)Costs (VC)
4. Marginal cost (MC)
Marginal Cost is the additional cost incurred
for the production of an additional unit of output.
Marginal cost is the extra expense associated
with producing one additional unit
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5. Cost output relationship
• The Cost-output relationship has 2 aspects:
– Cost-output relationship in the short run,
– Cost-output relationship in the long run
• The short run is a period which doesn’t permit
alterations in the fixed equipment (machinery, buildingalterations in the fixed equipment (machinery, building
etc) & in the size of the organization.
• The long run is a period in which there is sufficient
time to alter the equipment (machinery, building, land
etc.) & the size of the organization. Output can be
increased without any limits being placed by the fixed
factors of production.
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6. Cost-output relationship
in the short run
• The Short run may be studied in terms of
– Average Fixed Cost
– Average Variable Cost
– Average Total cost
• The Average Fixed Cost (TFC/Q) keep coming down as• The Average Fixed Cost (TFC/Q) keep coming down as
the production is increased and Average Variable Cost
(TVC/Q) will remain constant at any level of output.
• Marginal Cost is the addition to the total cost due to
the production of an additional unit of product. It can
be arrived at by dividing the change in total cost by the
change in total output.
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7. Cost-output relationship
in the short run
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8. Cost-output relationship
in the long run
• Long run period enables the producers to change
all the factor & he will be able to meet the
demand by adjusting supply. Change in Fixed
factors like building, machinery, managerial staff
etc.etc.
• All factors become variable in the long run.
• In the long run we have only 3 costs i.e. total cost,
Average cost & Marginal Cost.
• When all the short run situations are combined, it
forms the long run industry.
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9. Cost-output relationship
in the long run
• During the short run, Demand is less & the
plant’s capacity is limited. When demand
rises, the capacity of the plant is expanded.
• When short run average cost curves of all such• When short run average cost curves of all such
situations are depicted, we can derive a long
run cost curve out of that.
• We can make a long run cost curve by joining
the tangency points of all short run curves
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10. Cost-output relationship
in the long run
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11. Pricing Decisions
The amount of money charged for a
product or service, or the sum of the values
that consumers exchange for the benefits ofthat consumers exchange for the benefits of
having or using the product or service.
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12. Situations demanding pricing decisions /
Factors to consider when setting price
• The situations demanding pricing decisions may
be divided into external factors and internal
factors.
• The external factors are
The elasticity of supply and demand– The elasticity of supply and demand
– The goodwill of the company
– The extent of competition in the market
– The trend of market
– The purchasing power of the buyers and
– The government policies towards prices
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13. • The internal factors are
– The costs and
– The management policy towards the gross margin
and the sales turnover.
Situations demanding pricing decisions /
Factors to consider when setting price
and the sales turnover.
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14. Pricing Techniques in practice
The various pricing techniques in practice are
– Cost plus or full cost pricing
– Marginal cost pricing
– Going rate pricing– Going rate pricing
– Bid Pricing
– Target pricing or Pricing for a return
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15. Cost plus or Full Cost Pricing
• Full Cost pricing refers to a pricing method in
which some percentage of desired profit margins
is added to the cost of the product to obtain the
final price.
• In other words, Full cost pricing can be defined as• In other words, Full cost pricing can be defined as
a pricing method in which a certain percentage of
the total cost of production is added to the cost
of the product to determine its selling price.
• Full Cost pricing can be of two types, namely,
cost-plus pricing and markup pricing.
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16. Cost plus or Full Cost Pricing – Cost
Plus Pricing
Cost-plus Pricing:
• Cost plus pricing refers to the simplest method of
determining the price of a product. In cost-plus
pricing method, a fixed percentage, also called
mark-up percentage, of the total cost (as a profit)mark-up percentage, of the total cost (as a profit)
is added to the total cost to set the price.
• For example, XYZ organization bears the total cost
of Rs. 100 per unit for producing a product. It
adds Rs. 50 per unit to the price of product as’
profit. In such a case, the final price of a product
of the organization would be Rs. 150.
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17. Cost plus or Full Cost Pricing – Cost
Plus Pricing
• Advantages of cost-plus pricing method
– a. Requires minimum information
– b. Involves simplicity of calculation
– c. Insures sellers against the unexpected changes– c. Insures sellers against the unexpected changes
in costs
• Disadvantages of cost-plus pricing method
– a. Ignores price strategies of competitors
– b. Ignores the role of customers
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18. Cost plus or Full Cost Pricing – Make
up pricing method
Mark up pricing method
• Mark up pricing method refers to a pricing
method in which the fixed amount or the
percentage of cost of the product is added to
product’s price to get the selling price of theproduct’s price to get the selling price of the
product.
• Markup pricing is more common in retailing in
which a retailer sells the product to earn profit.
For example, if a retailer has taken a product
from the wholesaler for Rs. 100, then he/she
might add up a markup of Rs. 20 to gain profit.
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19. Marginal cost pricing
• Marginal Cost pricing refers to a pricing
method in which the price a product
according to its marginal cost.
• Marginal cost pricing focuses on variable or• Marginal cost pricing focuses on variable or
marginal cost (rather than indirect/fixed
costs), such as wages and raw material costs.
• It ignores any indirect/fixed costs in relation to
the product, such as rent or interest
payments.
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20. Marginal cost pricing
• If the price is set higher than the marginal costs
the surplus can be used to pay off the fixed costs.
Once the fixed costs are paid, this surplus will
become profit, so any price higher than the
marginal cost will be profitable for the firm.marginal cost will be profitable for the firm.
• Marginal cost pricing is likely to be most
appropriate where demand fluctuates
considerably - perhaps, for example, where
demand is seasonal or varies according to time of
day. Marginal cost pricing is frequently used by
utilities and public services.
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21. Marginal cost pricing
Advantages of marginal cost pricing
– It is a relatively simple pricing method - quick to calculate and
easy to implement
– Can help to smooth fluctuations in demand.
– It can be very useful where the firm has spare capacity and may
not be able to put its resources to other, perhaps morenot be able to put its resources to other, perhaps more
profitable, uses.
– Can be a useful way to attract other different market segments
into the market e.g. low peak train travellers may be attracted
by lower prices and only travel during the day because of low
prices - they may not otherwise have travelled.
– Can be a good way to remain in business and price-competitive
in a time of difficult trading. Prices can then be raised later
when the economic situation improves.
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22. Marginal cost pricing
Disadvantages of marginal cost pricing
– Not sustainable as a long-term pricing strategy as the
firm will need to recover the full costs of production.
– Can result in lower price expectations and make it– Can result in lower price expectations and make it
more difficult to raise prices again at a later stage.
– If markets are not fully separated then there can be
leakage between the markets with different prices.
Customers who might have paid a higher price may
take advantage of the lower marginal cost price.
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23. Going rate pricing
• Going rate pricing is a pricing strategy where
firms examine the prices of their competitors and
then set their own prices broadly in line with
these.
• Going rate pricing is most likely to occur where:• Going rate pricing is most likely to occur where:
– there is a degree of price leadership taking place
within a particular market
– businesses are reluctant to set significantly different
prices because of the risk of setting off a price war,
which would reduce profits to all firms
– there is a degree of collusion taking place between
firms
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24. Going rate pricing
• If there is one price leader and firms are tending
to follow the prices set by the price leader, then
they will often feel frustrated that they are not
able to mark themselves out by reducing theirable to mark themselves out by reducing their
prices.
• To compensate for this, they may try, through
their marketing strategy, to establish a strong
brand identity. This will enable them to
differentiate themselves from the competition.
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25. Bid Pricing
• Bid Pricing refers to the highest price that a
buyer (i.e., bidder) is willing to pay for a good.
A bidding war is said to occur when a large
number of bids are placed in rapid successionnumber of bids are placed in rapid succession
by two or more entities, especially when the
price paid is much greater than the ask price,
or greater than the first bid in the case of
unsolicited bidding.
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26. Bid Pricing
• In other words, bidding war is a situation
where two or more buyers are so interested in
an item (such as a house or a business) that
they make increasingly higher offers of thethey make increasingly higher offers of the
price they are willing to pay to try to become
the new owner of the item.
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27. Target pricing or Pricing for a return
The Target Pricing is a method wherein the
firm determines the price on the basis of a
target rate of return on the investment i.e.
what the firm expects from the investmentswhat the firm expects from the investments
made in the venture.
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28. Statutory requirements for pricing
The finance ministry reported to have evolved
in consultation with the ministries of Industry
and Commerce and Civil supplies some
guidelines for the fixation of prices of essential
commodities. Some of the main pointscommodities. Some of the main points
registered are
– The pricing should be fixed on the basis of the
average costs of the relatively more efficient firms
– Common rules would be worked out with respect
to technical issues involved in pricing fixation
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29. Statutory requirements for pricing
– Minimum bonus would not be included as part of the cost
of production but allowance would be made for the
minimum bonus while calculating the permissible net
return.
– The rate of return is to be calculated on the net worth of a– The rate of return is to be calculated on the net worth of a
company. The rate of return will have two components
– A basic minimum would be uniform as between industries
and
– An additional variable component which can be varied
between industries depending upon the differences in
factors like risk, the priority, growth prospects and capital
structure
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30. Statutory requirements for pricing
– There should be a cost variation formula to take care
of causes beyond the control of the manufacturers.
– Price determining bodies will be required to suggest
cost reduce measures where feasible and necessary.
– In industries where there are only a few large firms,– In industries where there are only a few large firms,
pooling arrangement with separate retention process
for different firms may be provided.
– A thorough review of prices and costs in price –
controlled industries should be taken up every three
years.
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