Pricing StrategiesPricing Strategies

Pricing StrategiesPricing Strategies

Penetration PricingPenetration Pricing

Penetration PricingPenetration Pricing► Price set to ‘penetrate the market’Price set to ‘penetrate the market’► ‘‘Low’ price to secure high volumesLow’ price to secure high volumes► Typical in mass market products – chocolate Typical in mass market products – chocolate

bars, food stuffs, household goods, etc.bars, food stuffs, household goods, etc.► Suitable for products with long anticipated Suitable for products with long anticipated

life cycleslife cycles► May be useful if launching into a new May be useful if launching into a new

marketmarket

Market SkimmingMarket Skimming

Market SkimmingMarket Skimming► High price, Low volumesHigh price, Low volumes► Skim the profit from the Skim the profit from the

marketmarket► Suitable for products Suitable for products

that have short life that have short life cycles or which will face cycles or which will face competition at some competition at some point in the future (e.g. point in the future (e.g. after a patent runs out)after a patent runs out)

► Examples include: Examples include: Playstation, jewellery, Playstation, jewellery, digital technology, new digital technology, new DVDs, etc.DVDs, etc.Many are predicting a firesale in

laptops as supply exceeds demand.

Value PricingValue Pricing

Value PricingValue Pricing► Price set in accordance Price set in accordance

with customer with customer perceptions about the perceptions about the value of the value of the product/serviceproduct/service

► Examples include Examples include status status products/exclusive products/exclusive products products Companies may be able to set prices

according to perceived value.

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Loss LeaderLoss Leader

Loss LeaderLoss Leader► Goods/services deliberately sold below cost to Goods/services deliberately sold below cost to

encourage sales elsewhereencourage sales elsewhere► Typical in supermarkets, e.g. at Christmas, Typical in supermarkets, e.g. at Christmas,

selling bottles of gin at £3 in the hope that selling bottles of gin at £3 in the hope that people will be attracted to the store and buy people will be attracted to the store and buy other thingsother things

► Purchases of other items more than covers Purchases of other items more than covers ‘loss’ on item sold‘loss’ on item sold

► e.g. ‘Free’ mobile phone when taking on e.g. ‘Free’ mobile phone when taking on contract packagecontract package

Psychological PricingPsychological Pricing

Psychological PricingPsychological Pricing►Used to play on consumer perceptionsUsed to play on consumer perceptions►Classic example - £9.99 instead of Classic example - £9.99 instead of

£10.99!£10.99!►Links with value pricing – high value Links with value pricing – high value

goods priced according to what goods priced according to what consumers THINK should be the priceconsumers THINK should be the price

Going Rate (Price Leadership)Going Rate (Price Leadership)

Going Rate (Price Leadership)Going Rate (Price Leadership)► In case of price leader, rivals have difficulty in In case of price leader, rivals have difficulty in

competing on price – too high and they lose market competing on price – too high and they lose market share, too low and the price leader would match share, too low and the price leader would match price and force smaller rival out of marketprice and force smaller rival out of market

► May follow pricing leads of rivals especially where May follow pricing leads of rivals especially where those rivals have a clear dominance of market those rivals have a clear dominance of market shareshare

► Where competition is limited, ‘going rate’ pricing Where competition is limited, ‘going rate’ pricing may be applicable – banks, petrol, supermarkets, may be applicable – banks, petrol, supermarkets, electrical goods – find very similar prices in all electrical goods – find very similar prices in all outletsoutlets

Tender PricingTender Pricing

Tender PricingTender Pricing► Many contracts awarded on a tender basisMany contracts awarded on a tender basis► Firm (or firms) submit their price for carrying Firm (or firms) submit their price for carrying

out the workout the work► Purchaser then chooses which represents best Purchaser then chooses which represents best

valuevalue► Mostly done in secretMostly done in secret

Price DiscriminationPrice Discrimination

Price DiscriminationPrice Discrimination► Charging a different Charging a different

price for the same price for the same good/service in good/service in different marketsdifferent markets

► Requires each market Requires each market to be impenetrableto be impenetrable

► Requires different price Requires different price elasticity of demand in elasticity of demand in each marketeach market

Prices for rail travel differ for the same journey at different times of the day

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Destroyer Pricing/Predatory Destroyer Pricing/Predatory PricingPricing

Destroyer/Predatory PricingDestroyer/Predatory Pricing► Deliberate price cutting or offer of ‘free Deliberate price cutting or offer of ‘free

gifts/products’ to force rivals (normally gifts/products’ to force rivals (normally smaller and weaker) out of business or smaller and weaker) out of business or prevent new entrantsprevent new entrants

► Anti-competitive and illegal if it can be Anti-competitive and illegal if it can be provedproved

Absorption/Full Cost Absorption/Full Cost PricingPricing

Absorption/Full Cost PricingAbsorption/Full Cost Pricing►Full Cost PricingFull Cost Pricing – attempting to set – attempting to set

price to cover both fixed and variable price to cover both fixed and variable costscosts

►Absorption Cost PricingAbsorption Cost Pricing – Price set to – Price set to ‘absorb’ some of the fixed costs of ‘absorb’ some of the fixed costs of productionproduction

Marginal Cost PricingMarginal Cost Pricing

Marginal Cost PricingMarginal Cost Pricing► Marginal cost – the cost of producing ONE Marginal cost – the cost of producing ONE

extra or ONE fewer item of productionextra or ONE fewer item of production► MC pricing – allows flexibility MC pricing – allows flexibility ► Particularly relevant in transport where fixed Particularly relevant in transport where fixed

costs may be relatively highcosts may be relatively high► Allows variable pricing structure – e.g. on a Allows variable pricing structure – e.g. on a

flight from London to New York – providing flight from London to New York – providing the cost of the extra passenger is covered, the cost of the extra passenger is covered, the price could be varied a good deal to the price could be varied a good deal to attract customers and fill the aircraftattract customers and fill the aircraft

Marginal Cost PricingMarginal Cost Pricing►Example:Example:

Aircraft flying from Bristol to Edinburgh – Total Cost (including normal profit) = £15,000 of which £13,000 is fixed cost*Number of seats = 160, average price = £93.75MC of each passenger = 2000/160 = £12.50If flight not full, better to offer passengers chance of flying at £12.50 and fill the seat than not fill it at all! *All figures are estimates only

Contribution PricingContribution Pricing

Contribution PricingContribution Pricing► Contribution = Selling Price – Variable (direct Contribution = Selling Price – Variable (direct

costs)costs)► Prices set to ensure coverage of variable Prices set to ensure coverage of variable

costs and a ‘contribution’ to the fixed costscosts and a ‘contribution’ to the fixed costs► Similar in principle to marginal cost pricingSimilar in principle to marginal cost pricing► Break-even analysis might be useful in such Break-even analysis might be useful in such

circumstancescircumstances

Target PricingTarget Pricing

Target PricingTarget Pricing►Setting price to ‘target’ a specified Setting price to ‘target’ a specified

profit levelprofit level►Estimates of the cost and potential Estimates of the cost and potential

revenue at different prices, and thus revenue at different prices, and thus the break-even have to be made, to the break-even have to be made, to determine the mark-updetermine the mark-up

►Mark-up = Profit/Cost x 100Mark-up = Profit/Cost x 100

Cost-Plus PricingCost-Plus Pricing

Cost-Plus PricingCost-Plus Pricing►Calculation of the average cost (AC) Calculation of the average cost (AC)

plus a mark upplus a mark up►AC = Total Cost/OutputAC = Total Cost/Output

Influence of ElasticityInfluence of Elasticity

Influence of ElasticityInfluence of Elasticity► Any pricing decision must be mindful of the Any pricing decision must be mindful of the

impact of price elasticity impact of price elasticity ► The degree of price elasticity impacts on the The degree of price elasticity impacts on the

level of sales and hence revenuelevel of sales and hence revenue► Elasticity focuses on proportionate Elasticity focuses on proportionate

(percentage) changes(percentage) changes► PED = % Change in Quantity PED = % Change in Quantity

demanded/% Change in Pricedemanded/% Change in Price

Influence of ElasticityInfluence of Elasticity► Price Inelastic:Price Inelastic:► % change in Q < % change in P% change in Q < % change in P► e.g.e.g. a 5% increase in price would be met by a 5% increase in price would be met by

a fall in sales of something less than 5% a fall in sales of something less than 5% ► Revenue would riseRevenue would rise► A 7% reduction in price would lead to a rise A 7% reduction in price would lead to a rise

in sales of something less than 7%in sales of something less than 7%► Revenue would fallRevenue would fall

Influence of ElasticityInfluence of Elasticity► Price Elastic:Price Elastic:► % change in quantity demanded > % % change in quantity demanded > %

change in pricechange in price► e.g.e.g. A 4% rise in price would lead to sales A 4% rise in price would lead to sales

falling by something more than 4%falling by something more than 4%► Revenue would fallRevenue would fall► A 9% fall in price would lead to a rise in A 9% fall in price would lead to a rise in

sales of something more than 9%sales of something more than 9%► Revenue would riseRevenue would rise

National incomeNational income1.It is the sum total of factor incomes earned 1.It is the sum total of factor incomes earned

by normal residents of a country during the by normal residents of a country during the period of one year.period of one year.

NY=NY=∑FY∑FYii= sum of factor incomes.= sum of factor incomes.2.National income is also defined as sum total 2.National income is also defined as sum total

of market value of final goods & of market value of final goods & services,produced by normal residents of a services,produced by normal residents of a country in a year.country in a year.

NY=∑PG= Mkt. Value of final goods & services NY=∑PG= Mkt. Value of final goods & services ProducedProduced

3.NY=C+I= Sum total of expenditure on final 3.NY=C+I= Sum total of expenditure on final goods & services producedgoods & services produced

►Gross domestic product (GDP)Gross domestic product (GDP) is a is a measure of the income and measure of the income and expenditures of an economy.expenditures of an economy.

► It is the total market value of all It is the total market value of all final goods and services produced final goods and services produced within a country in a given period within a country in a given period of time.of time.

Gross Domestic Product

The Circular-Flow Diagram

The equality of income The equality of income and expenditure can be and expenditure can be illustrated with theillustrated with the circular-flow diagramcircular-flow diagram..

The Circular-Flow Diagram

Firms Households

Market for Factors

of Production

Market for Goods

and Services

SpendingRevenue

Wages, rent, and

profit

Income

Goods & Services

sold

Goods & Services bought

Labor, land, and capital

Inputs for production

The Measurement of GDP► Output is valued at Output is valued at market pricesmarket prices..► It records only the value of It records only the value of final goodsfinal goods, ,

not not intermediate goodsintermediate goods (the value is (the value is counted only once).counted only once).

► It includes both It includes both tangible goodstangible goods (food, (food, clothing, cars) and clothing, cars) and intangible servicesintangible services (haircuts, housecleaning, doctor (haircuts, housecleaning, doctor visits). visits).

► It measures the value of production It measures the value of production that takes place that takes place within a specific within a specific interval of timeinterval of time, usually a year or a , usually a year or a quarter (three months). quarter (three months).

The Measurement of GDP

What Is Counted in GDP?

GDP includes all items GDP includes all items produced in the produced in the economy and sold economy and sold legally in markets.legally in markets.

What Is Not Counted in GDP?► GDP excludes most items that are GDP excludes most items that are

produced and consumed at home produced and consumed at home and that never enter the and that never enter the marketplace.marketplace.

► It excludes items produced and sold It excludes items produced and sold illicitly, such as illegal drugs.illicitly, such as illegal drugs.

Other Measures of Income►Gross National Product (GNP)Gross National Product (GNP)►Net National Product (NNP)Net National Product (NNP)►National IncomeNational Income►Personal IncomePersonal Income►Disposable Personal IncomeDisposable Personal Income

Gross National Product► Gross national product (GNP)Gross national product (GNP) is the total is the total

income earned by a nation’s permanent income earned by a nation’s permanent residents (called nationals).residents (called nationals).

► It differs from GDP by including income It differs from GDP by including income that our citizens earn abroad and that our citizens earn abroad and excluding income that foreigners earn excluding income that foreigners earn here.here.

Net National Product (NNP)► Net National Product (NNP)Net National Product (NNP) is the is the

total income of the nation’s total income of the nation’s residents (GNP) minus losses from residents (GNP) minus losses from depreciation.depreciation.

► DepreciationDepreciation is the wear and tear on is the wear and tear on the economy’s stock of equipment the economy’s stock of equipment and structures.and structures.

National Income► National IncomeNational Income is the total income is the total income

earned by a nation’s residents in the earned by a nation’s residents in the production of goods and services.production of goods and services.

► It differs from NNP by excluding It differs from NNP by excluding indirect business taxesindirect business taxes (such as sales (such as sales taxes) and including business taxes) and including business subsidies. subsidies.

Personal Income► Personal incomePersonal income is the income that is the income that

households and noncorporate businesses households and noncorporate businesses receive.receive.

► Unlike national income, it excludes Unlike national income, it excludes retained earningsretained earnings, which is income that , which is income that corporations have earned but have not corporations have earned but have not paid out to their owners. paid out to their owners.

► In addition, it includes household’s In addition, it includes household’s interest interest incomeincome and government and government transferstransfers. .

Disposable Personal Income► Disposable personal incomeDisposable personal income is the is the

income that household and income that household and noncorporate businesses have left noncorporate businesses have left after satisfying all their obligations to after satisfying all their obligations to the government.the government.

► It equals personal income minus It equals personal income minus personal taxes and certain nontax personal taxes and certain nontax payments.payments.

The Components of GDP

GDP (GDP (Y Y ) is the sum of the following:) is the sum of the following: Consumption Consumption ((CC)) Investment Investment ((II)) Government Purchases Government Purchases ((GG)) Net Exports Net Exports ((NXNX))

Y = C + I + G + NXY = C + I + G + NX

The Components of GDP► Consumption Consumption (C)(C)::

The spending by households on goods and The spending by households on goods and services, with the exception of purchases services, with the exception of purchases of new housing.of new housing.

► Investment Investment (I)(I):: The spending on capital equipment, The spending on capital equipment,

inventories, and structures, including inventories, and structures, including new housing.new housing.

The Components of GDP

► Government Purchases Government Purchases (G)(G):: The spending on goods and services by The spending on goods and services by

local, state, and federal governments.local, state, and federal governments. Does Does notnot include transfer payments include transfer payments

because they are not made in exchange because they are not made in exchange for currently produced goods or services.for currently produced goods or services.

► Net ExportsNet Exports (NX)(NX):: Exports minus imports.Exports minus imports.

Net Exports -2 %

GDP and Its Components (1998)

Consumption 68 %

Investment16%

Government Purchases

18%

GDP Deflator► The The GDPGDP deflatordeflator measures the measures the

current level of prices relative to the current level of prices relative to the level of prices in the base year.level of prices in the base year.

► It tells us the rise in nominal GDP that It tells us the rise in nominal GDP that is attributable to a rise in prices rather is attributable to a rise in prices rather than a rise in the quantities produced. than a rise in the quantities produced.

GDP Deflator

100GDP RealGDP Nominal=deflator GDP

The GDP deflator is calculated as follows:The GDP deflator is calculated as follows:

Real versus Nominal GDP

► Nominal GDPNominal GDP values the production of values the production of goods and services at current prices.goods and services at current prices.

► Real GDPReal GDP values the production of values the production of goods and services at constant goods and services at constant prices.prices.

GDP and Economic Well-Being

► GDP is the best single measure of GDP is the best single measure of the economic well-being of a the economic well-being of a society. society.

► GDP per personGDP per person tells us the income tells us the income and expenditure of the average and expenditure of the average person in the economy.person in the economy.

GDP and Economic Well-Being

► Higher GDP per person indicates a Higher GDP per person indicates a higher standard of living.higher standard of living.

► GDP is not a perfect measure of the GDP is not a perfect measure of the happiness or quality of life, however.happiness or quality of life, however.

Methods of measuring National Methods of measuring National IncomeIncome

►Product Method or Value added Product Method or Value added methodmethod

► Income MethodIncome Method

►Expenditure MethodExpenditure Method

InflationInflation►This is the process by which the This is the process by which the

price level rises and money loses price level rises and money loses value.value.

►There are two kinds of inflation:There are two kinds of inflation:►a) Demand pulla) Demand pull►b) Cost pushb) Cost push

Demand pull inflationDemand pull inflation►Demand pull inflation may be due Demand pull inflation may be due

to :to :a)a)Increase in money supplyIncrease in money supplyb)b)Increase in government purchasesIncrease in government purchasesc)c)Increase in exportsIncrease in exports

Cost pushCost push►Cost push inflation may arise Cost push inflation may arise

because of :because of :a)a)Increase in money wage ratesIncrease in money wage ratesb)b)Increase in money prices of raw Increase in money prices of raw

materials.materials.

► Unanticipated inflation is bad because it makes Unanticipated inflation is bad because it makes the economy behave like a giant casino. the economy behave like a giant casino.

► Gains and losses occur because of unpredictable Gains and losses occur because of unpredictable changes in the value of money.changes in the value of money.

► If the value of money varies unpredictably over If the value of money varies unpredictably over time, the quantity of goods and services that time, the quantity of goods and services that money will buy will also fluctuate unpredictably.money will buy will also fluctuate unpredictably.

► Resources are also diverted from productive Resources are also diverted from productive activities to forecasting inflation.activities to forecasting inflation.

► Unanticipated inflation leads to :Unanticipated inflation leads to :a)a) Redistribution of income, borrowers and lendersRedistribution of income, borrowers and lendersb)b) Too much or too little lending or borrowingToo much or too little lending or borrowing

Measures to check inflationMeasures to check inflation1.Monetary measures1.Monetary measures Credit controlCredit control Demonetization of currencyDemonetization of currency Issue of new currencyIssue of new currency2.Fiscal Measures2.Fiscal Measures Reduction in unnecessary expenditureReduction in unnecessary expenditure Increase in taxesIncrease in taxes Increase in savingsIncrease in savings

Contd……Contd……3.Other measures3.Other measures To increase productionTo increase production Rational wage policyRational wage policy rationingrationing Price controlPrice control

PeakPeak

TroughTrough

Recovery

Recovery

Recession

Recession

PeakPeak

√ The term The term business cyclebusiness cycle refers refers to the recurrent ups and downs in the to the recurrent ups and downs in the level of economic activity, which level of economic activity, which extend over several years. extend over several years.

√ √ Individual business cycles may Individual business cycles may vary greatly in duration and intensity.vary greatly in duration and intensity.

√ √ All display a set of phases.All display a set of phases.

Business CyclesBusiness Cycles

PEAKPEAK

Time

GROWTHGROWTH

TRENDTREND

√ √ Peak or prosperity phase: Peak or prosperity phase: Real output in the economy is at a Real output in the economy is at a high levelhigh level Unemployment is low Unemployment is low Domestic output may be at its Domestic output may be at its capacitycapacity Inflation may be high.Inflation may be high.

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√ √ Contraction or recession phase:Contraction or recession phase: Real output is decreasing Real output is decreasing Unemployment rate is rising. Unemployment rate is rising. As contraction continues, inflation pressure fades.As contraction continues, inflation pressure fades. If the recession is prolonged, price may decline (deflation) If the recession is prolonged, price may decline (deflation) The government determinant for a recession is two The government determinant for a recession is two consecutive quarters of declining output. consecutive quarters of declining output.

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RECESSIONRECESSIONGROWTHGROWTH

TRENDTREND

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TROUGHTROUGH

GROWTHGROWTH

TRENDTREND

√ √ Trough or depression phase:Trough or depression phase: Lowest point of real GDPLowest point of real GDP Output and unemployment “bottom out”Output and unemployment “bottom out” This phase may be short-lived or prolongedThis phase may be short-lived or prolonged There is no precise decline in output at which a There is no precise decline in output at which a serious recession becomes a depression. serious recession becomes a depression.

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RECOVERYRECOVERY

GROWTHGROWTH

TRENDTREND

√ √ Expansionary or recovery: Expansionary or recovery: Real output in the economy is increasing Real output in the economy is increasing Unemployment rate is decliningUnemployment rate is declining The upswing part of the cycle. The upswing part of the cycle.

PeakPeak

TroughTrough

One cycleOne cycle

Recovery

Recovery

Rea

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PR

eal G

DP

per

year

per

year

Recession

Recession

TimeTime

PeakPeak

Business Cycle-one cycle through 4 phasesBusiness Cycle-one cycle through 4 phases

Innovation Innovation Political eventsPolitical events

Random events Random events WarsWars

Level of consumer spendingLevel of consumer spendingSeasonal fluctuationsSeasonal fluctuations

Cyclical Impacts — durable and non durable Cyclical Impacts — durable and non durable

Causes of FluctuationsCauses of Fluctuations

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