3. Pricing : It’s Importance
Important component of Revenue.
Very sensitive w.r.t. common goods.
Much more important for poor and lower-
middle class income group people.
Change in price has very sharp impact on
profitability.
Recently, Price is getting more tricky.
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4. Pricing : It’s Importance
Pricing and its impact on profitability
Hinterhuber,A, Towards value-based pricing—An integrative framework for decision making, Industrial Marketing
Management 33 (2004) 765– 778
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5. Learning Objectives
Basic Concepts of Pricing
Four market/competition
structures
Pure competition and Perfect
competition
Pricing in Perfect Competition
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6. Pricing Timeline : Short-run
pricing
time horizon of less than one year
Pricing a one-time-only order
This include decisions such as:
Adjusting product mix and output
volume in a competitive market
High return aim
Variable Component changes
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7. Pricing Timeline : Long-run
pricing
one year or longer time span
include decisions such as:
All factor including fixed costs can be
altered
Profit margin is set to earn a reasonable
return on investment
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8. Pricing Approaches
Market-Based:
price charged is based on what customers want
and how competitors react. Starts with a target
price.
Estimated on customers’ perceived value and
how competitors price competing
products/services
Cost-Based:
price charged is based on what it cost to
produce, coupled with the ability to recoup the
costs and achieve a required rate of return.
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9. Markets and Pricing
Approach
Competitive Markets – use the market-
based approach
Less-Competitive Markets – can use
either the market-based or cost-based
approach
Non-competitive Markets – use cost-
based approaches
What pricing model NLC uses ?
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10. Pricing Factors
Pricing ultimately depends on it’s demand
and supply
Factors those influences the Price
Customers – their demand for product/service,
based on factors such as quality and product
features.
Competitors – their pricing schemes, based
on product features, production volume etc
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11. Pricing Factors
Costs – they affect supply (the lower the
cost, the greater the quantity a firm is
willing to supply)
Regulatory environment/ Govt Policy –
Taxes/Subisdies
More Tax on some items
Less Tax on some other items
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12. Price Elasticity
price changes impact sales volume
Demand is elastic if a price increase has a
large negative impact on sales volume.
Demand is inelastic if a price increase has
little or no impact on sales volume.
𝑃𝐸𝐷 =
Δ𝑄
Δ𝑃
Factors:
Availability of substitute, income level,
Necessity, Duration, Brand loyalty, Who pays!!
For Electricity, Rice & Exceptions ?
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13. Who determines the price?
Price takers – company in competitive
market has no influence on price
As competition increase, the price becomes
squeezed between the cost of the product
and the lowest price of a competitor.
Price makers - companies that influence the
price
Organizations that compete by offering
innovative products/services have a more
difficult pricing decision.
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14. Types of Competition/Market
Perfect competition
large number of relatively small buyers and
sellers
standardized product
very easy market entry and exit
No non-price competition
Most Free Market Economist advocate for
this type, WHY ?
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15. Types of Competition/Market
Imperfect Markets
Monopoly (absolute market power)
one firm, firm is the industry
unique product or no close substitutes
market entry and exit difficult or legally
impossible
non-price competition not necessary
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16. Types of Competition/Market
Imperfect Markets
Monopolistic competition
large number of small firms acting
independently
differentiated product
market entry and exit relatively easy
non-price competition very important
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17. Types of Competition/Market
Imperfect Markets
Oligopoly
small number of large mutually
interdependent firms
each firm is affected by the decisions of its
rival
differentiated or standardized product
market entry and exit difficult
non-price competition important
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20. Types of Competition/Market
Examples: monopoly
pharmaceuticals with patents
regulated utilities (although this is changing)
Indian Railway
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25. Pure competition
Large no. of firms each produce a tiny
fraction of market supply.
Important Characteristics
large number of independent sellers
homogeneous product.
Examples: farm commodities (wheat,
soybean, strawberries, milo)
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26. Perfect Competition
large number of independent, relatively
small sellers and buyers as compared to
the market size,
no individual buyer or seller has any
influence over the price.
economic forces operate to full extent
allows best allocation of resources to
maximize efficiency
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27. Perfect Competition
Important Characteristics
large number of independent sellers
identical product
No barriers to entry and exit : no need of
patents, very high capital expenditure,
regulated market, licencing
complete information, absence of
transport cost, perfect mobility of factors.
stock market, and the foreign exchange
market
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28. Pure and Perfect Competition
Basic Difference
Only two conditions in Pure Competition,
which ensures no question of monopoly
control
Four condition in Perfect competition
Buyers and sellers are price takers in both
cases.
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29. Price & Output Decision :
business decision questions
What to Produce and How much to
produce?
How much profit will be earned?
If a loss is incurred, will it be worthwhile to
continue in this market in the long run or
should exit ?
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30. Price & Output Decision :
Perfect Competition
Key assumptions
Firm is a price taker
Firm makes the distinction between the short
run and the long run
Firm’s objective – profit maximization (or
loss minimization) in the short run
Firm includes its opportunity cost of
operations in its total cost of production
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31. Price & Output Decision :
Perfect Competition
Demand Curve
Perfectly elastic demand curve: consumers are
willing to buy as much as the firm is willing to
sell at the going market price
The firm receives the same MR from the sale
of each additional unit of product = P
No limit to the total revenue that the firm can
gain in a perfectly competitive market
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33. Price & Output Decision :
Perfect Competition
Only the industry as a whole, which determines the
market demand curve, can affect price by
changing industry output.
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34. Pricing Mechanism: Some Basic
Concepts
Total revenue (TR) - total amount received by a
firm from the sale of a product.
TR = P x Q
Average revenue (AR) - total revenue from the sale
of a product divided by the quantity of that product
sold.
AR = TR ÷ Q
Marginal revenue (MR) – the change in total
revenue that results from selling 1 more unit of
output.
MR = ( change in TR) ÷ (change in Q)
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35. Pricing Mechanism: Some Basic
Concepts
If MR is constant, each additional unit of
output sold adds the same amount to TR.
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36. Pricing Mechanism
Total revenue/Total cost approach:
Compare the TR and TC schedules, find the level of
output that
maximizes the firm’s profits or minimizes its loss.
Marginal revenue/Marginal cost approach:
Level of output at which the additional revenue received
from
the last unit is equal to the additional cost of producing
that unit
(at MR=MC)
Both the TR/TC and MR=MC approach lead to the same
price/output decision
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37. Production Levels
Case A: economic
profit
The point where
P=MR=MC
is optimal output (Q*)
Profit = TR – TC
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38. Production Levels
Case B: economic loss
The firm incurs a loss.
At optimum
output(MR=MC),
P < AC
If P > AVC, the firm
is better off producing in
the short run, b’coz of
fixed costs incurred.
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39. Production Levels
Case C: Shutdown point: the lowest price at
which the firm would still produce
At this point, P = the minimum point on the AVC.
Price below this point, revenues fail to cover the
fixed costs and the variable costs. The firm
would be better off if it shut down.
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40. Production Levels in Short run :
Competitive Market
Profit maximizing output
individual firm cannot influence the market price,
horizontal demand curve i.e. perfectly elastic – its
elasticity is infinity at all levels of output.
Marginal Revenue (MR) curve horizontal and
coincides with AR curve. AR and MR are constant
and equal at all output.
MR = MC rule
The firm can adjust its variable resources (but not
fixed resources) to achieve the output level that
maximizes profit.
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41. Production Levels in Long run :
Competitive Market
In long run, Price in the competitive market
settle where firms earn a normal profit.
Economic profit
Entry of new firms
Shifts the supply curve to the right
Puts downward pressure on price
Reduces profits to normal levels
Economic loss
Opposite effect of the above
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42. Perfectly competitive markets in
action
the earlier the firm enters - better chances
of earning above-normal profit – for longer
period
new firms must find lowest possible
production cost
Otherwise try competing by product
differentiation
All firms in the industry have identical cost
curves
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43. Perfectly competitive markets in
action
At long-run equilibrium, firms earn zero
economic profit and earn a normal profit.
P (=MR) = MC = minimum ATC
Firms use the limited resources in a way to
maximize the satisfaction of consumers.
This leads to higher efficient resource
allocation, more productivity, innovation and
altogether more business.
That’s Why Most Free Market Economist
advocate for Market type.
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