Pricing in Economy :: SSC CGL / CHSL Study Material
Pricing in Economy :: SSC CGL / CHSL Study Material
Pricing is the process of determining what a company will receive in exchange for its product or service. A business can use a variety of pricing strategies when selling a product or service. The price can be set to maximize profitability for each unit sold or from the market overall. It can be use to defend an existing market from new entrants, to increase market share within a market or to enter a new market.
The theory of price is an economic theory that contends that the price for any specific good/service is based on the relationship between the forces of supply and demand . The theory of price says that the point at which the benefit gained from those who demand the entity meets the seller’s marginal costs is the most optimal market price for the good/service.
Types of pricing strategies
1. Profit maximization-
One strategy is to ignore market share and try to work out the price for profit maximisation. In theory this occurs at a price where MR=MC. In practise it can be difficult to work this out precisely.
2. Sales maximization-
Aiming to maximise sales whilst making normal profit. This involves selling at a price equal to average cost.
3. Gaining Market Share-
Some firms may have a target to increase market share, this could involve setting prices as low as they can afford, leading to a price war. A similar concept to sales maximisation.
Strategies to attract customers / increase profit
1. Premium pricing-
This occurs when a firm makes a good more expensive to try and give the impression that it is better quality, e.g. ‘premium unleaded fuel’, fashion labels.
2. Loss Leaders-
This involves setting a low price on some products to entice customers into shop where hopefully they will also buy other goods as well. However, it is illegal to sell goods below cost, so firms could be investigated by OFT.
3. Price Discrimination-
This involves charging a different price to different groups of consumers to take advantage of different elasticities of demand. There are different types of price discrimination from second degree to third degree.
This involves setting an artificially high price to be able to later offer discounts on previously advertised price.
5. Price Matching-
The purpose behind price matching is making a promise to match any price cuts by your competitors. The argument is that this discourages your competitors from cutting price. This is because they know there is little point in cutting prices, because you will respond straight away. Very clear price matching stance’s can thus avoid price wars and give the impression of being very competitive. For example, Tesco are offering £10 voucher to customers who can prove their shopping basket would have been cheaper at other supermarkets.
Retail price mechanism RPM – when manufacturers set minimum prices for retailers, e.g. net book agreement.
6. Psychological pricing-
Setting price at important psychological levels to trigger purchase, e.g. selling good at £9.99 to make it appear cheaper. Some firms use reverse psychology and charge exact prices, e.g. clothes for £40 to indicate quality rather than cheapness.
7. Premium decoy pricing-
Where a firm sets the price of one good deliberately high to encourage demand for lower price. e.g. a car company may bring out a top of the range sports car, which is very expensive to make the general brand more attractive.
8. Pay what you want-
A situation where consumers are left free to decide how much to pay, e.g. restaurants cafe where there is no cost – only tipping. When music companies release a new recording and ask for donations.
9. Bundle pricing-
When a firm gives special offers, e.g. buy 3 for the price of 2 – very common for book sales e.t.c.
When a firm releases a new product, it initially sets a high price to take advantage of those consumers with inelastic demand. Over time, the price is reduced to attract those customers with more price elastic demand.
11. Penetration pricing-
When a firm sets a low price to help establish market share and get established. For example a new printing company may offer very low price for its printers to get established. Then it get make profits on selling ink and over time increase the price. Or satellite tv company offering introductory offer for a few months.
12. Optional pricing-
When a firm tries to receive a higher price by selling extras. For example, if you buy a DVD, you can get sold insurance or additional features.
13. Dynamic pricing-
When prices are regularly updated in response to shifting market conditions. For example, if an airline receives high demand for certain flights, it will increase the price to help fill up other departure times and maximise revenue from the flight.
Strategies to cement market share / market position
- Limit pricing- This occurs when a monopoly set price lower than profit maximisation to discourage entry. This enables the firm to make supernormal profit, but the price is still low enough to deter new firms to enter the market.
- Predatory pricing- Selling price below cost to try and force rival out of business. It is illegal. Predatory pricing can be make easier through cross Subsidisation. This occurs when a big multinational may use profits in one area to subsidise a price war in another. The cross subsidisation enables a firm to sell a product very competitively (or even at a loss) to try and force the rival firms out of business.
Strategies to help determine the price
- Average cost pricing- When a firm sets the price equal to average cost plus a certain profit margin.
- Market based pricing- When firms set a price depending on supply and demand. For example, if football clubs, use market based pricing, clubs like Manchester United would probably increase the ticket price – because at the moment, all tickets are sold out – suggesting price is below the equilibrium.
- Mark-up pricing- This involves setting a price equal to marginal cost of production + x. (where x = the profit margin a firm wants to make on each sale).
- Profit maximization- Setting price and quantity so MR=MC.
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