In economic practices, there are several methods to determine the price and quantity of the goods and services. Determination of price and output depends on the objectives of the firm as well as competitors, the nature of the commodity, markets scope and so on. In these slides, I try to show, how price and output determine by using cost-plus and incremental cost techniques.

1. Pricing Techniques/
Pricing Practices
Indra Prasad Pyakurel

2.  In cost-plus pricing method, a fixed
percentage, also called 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.
Indra Prasad Pyakurel

3.  Cost-plus pricing is also known as average
cost pricing or full cost pricing or mark-up
pricing .This is the most commonly used
method in manufacturing organizations.
 In this method, following decisions related to
price should be made:-
1. Estimation of cost
2. Choice of fair profit margin
Indra Prasad Pyakurel

4. Determination of Average Cost (AC)
In the short run,
TC =TFC +TVC,
Dividing both sides by Q, then,
TC/Q =TFC/Q +TVC/Q
AC = AFC +AVC
Price Determination
P = AVC + AFC+ NMC = AVC + GPM
Indra Prasad Pyakurel

5. Mark-up on Cost
M = (P-C) /C
Or, P-C = CM
Or, P = C + CM
P = C(1 +M)
Mark-up on Price
M = (P-C) /P
Or, P-PM = C
Or, P(1-M) = C
P = C/(1 -M)
Indra Prasad Pyakurel

6.  When costs are sufficiently stable for long periods, there is
price stability which is both cheaper administratively and
less irritating to retailers and customers.
 The cost-plus formula is simple and easy to calculate.
 The cost-plus method offers a guarantee against loss-
making by a firm. If it finds that costs are rising, it can take
appropriate steps by variations in output and price.
 When the firm is unable to forecast the demand for its
product, the cost-plus method can be used.
 When it is not possible to gather market information for
the product or it is expensive, cost- plus pricing is an
appropriate method.
 Cost-plus pricing is suitable in such cases where the
nature and extent of competition is unpredictable.
Indra Prasad Pyakurel

7.  This method is based on costs and ignores the
demand of the product which is an important variable
in pricing.
 It is not possible to accurately ascertain total costs
in all cases.
 This pricing method seems naive because it does not
explicitly take into account the elasticity of demand
 Cost-plus pricing method is based on accounting
data for total cost and not the opportunity cost
that the sale of product incurs.
 This method cannot be used for price determination
of perishable goods because it relates to long period.
Indra Prasad Pyakurel

8.  Question:-
 An automobile manufacturer estimates that
total variable costs will be $500 million and total
fixed cost will be $1 billion in the next year. In
setting prices, it is assumed that sales will be
80% of the firm’s 125,000- vehicles- per-year
capacity, or 100,000 units.The target rate of
return is 10% , which is to be earned on an
investment of $2 billion. If prices are set on a
cost-plus basis, what price should be charged for
each automobile?
Indra Prasad Pyakurel

9. A target return of 10% OR $2 billion requires that
the firm earn a total profit of $200 million.
Computations are based sales of 100,000
vehicles.Thus, AFC, AVC, and profit per unit are:
AFC = $1000,000,000/100,000 = $10,000
AVC = $500,000,000/100,000 = $5000
AC = AFC + AVC = $10,000 +$5000 = $15,000
Per Unit profit =Total Profit /Total Units
=$200,000,000/100,000 = $2,000
Hence, if profit of $2000 per vehicle is added to the
$15,000 In cost , the price will be $17000 per car.
Indra Prasad Pyakurel

10.  It is the method of pricing a product based on
incremental cost.
 In this type of pricing, the selling price of a
product is determined by the variable cost, and
not kept according to the overall cost of creating
the product.
 Incremental cost is the cost of creating
additional products from the same setup (i.e.
R&D, factory, machinery being same as used for
other products), i.e. the fixed cost remains same,
and the selling price of the product thus
generated is based mainly on the variable cost.
Indra Prasad Pyakurel

11.  For example, a company that has been making
packets of biscuits, with 8 biscuits per packet,
launches a new product, that is a 15-biscuits
packet.The R&D, machinery, land on which the
machinery (or factory) is remains same. So the
fixed cost, like the rent of the land, the initial
cost of setting up the machinery and that
incurred in R&D of the biscuit remain same.The
variable cost changes.This includes the cost of
the extra volume of ingredients, bigger packets,
extra oil/electricity used to run the machinery.
Indra Prasad Pyakurel

12.  In the regular pricing method, the selling
price of each product (each packet of biscuit)
will include the distributed fixed costs (fixed
cost per packet) + distributed variable cost +
profit margin.
 In the incremental cost pricing method, the
selling price of the product will be based on
only the latter two.This method is used only
when the fixed overhead is being absorbed by
existing product sales.
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13.  The advantage of incremental cost pricing is that it can be used to
launch a new product with low cost so that it is readily accepted
in the market, and also to open up a new customer base by
reducing the price of an existing product.
 The disadvantage is that if not used judicially, the company may
end up applying it to all products.
 The reduced prices may force the competitor to apply the same
method as well.Thus, incremental cost pricing may become a
norm.When all products are being sold using incremental cost
pricing, it may be difficult to absorb the fixed cost overhead,
resulting in the reduction of a company’s profitability.This may
ultimately lead to perpetual losses, hence resulting in the failure
of the product line or the company on the whole.
Indra Prasad Pyakurel

14.  NeconAir is planning to run extra flight from
Biratnagar to Colkatta.The fully allocated
cost of the flight is Rs. 45000, the out of
pocket cost is Rs. 20000 and the gross
revenue of the flight is Rs. 31000. Explain on
the basis of incremental pricing technique
whether NeconAir should run the flight of
not? Also explain the superiority of this
technique over full cost pricing technique.
Indra Prasad Pyakurel