Theory of Pricing
THEORY OF PRICING
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Introduction
·
Theory of pricing is an
economic theory which states that the price for any specific good is based on
the relationship between the forces of supply and demand
·
It also states 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
·
According to this theory a perfect
competitive market must meet the below mentioned requirements
o Number of firms is large
o No barriers to entry
o Firm’s products are identical
o Availability of complete information
o Profit maximizers
·
This theory defines two different situation
of a market
o Monopoly
§ A situation of market in which there is a single seller
of a product
§ Example can be the presence of a single firm dealing in
the sale of cooking gas in a particular town
§ In this situation there is only one producer of a
commodity with no close substitutes
§ The characteristics of monopolistic competition are
·
Numerous participants
·
Freedom of exit & entry
·
Heterogeneous products
·
Selling cost
·
Imperfect knowledge
o Oligopoly
§ A state of limited competition in which a market is
shared by a small number of producers/sellers
§ Example can be the Auto industry and Cigarette industry
§ The characteristics of Oligopolistic competition are
·
Few firms
·
Substantial barriers to entry
·
Price rigidity
·
Positive profits
·
Price leadership
Types
of Pricing
·
Cost Plus Pricing
o
The selling price is found out by adding a
certain % mark-up to the average variable cost
o
The mark-up Or Contribution Margin contributes
towards fixed cost and profit
o
Price = AVC + CM
o
It ignores the influence of demand on price
o
It helps in fixing a fair price
o
Cost is considered as the main factor
influencing price
·
Marginal Cost Pricing
o
The prices are fixed on the basis of marginal
cost
o
Fixed costs are ignored and only those costs
that are directly attributable to product are taken
o
It is a short-run phenomenon
o
It is generally adopted when the product is
introduced in a new market
o
It helps to ascertain the changes in cost due
to pricing decision
o
It helps to increase marginal physical
productivity and thereby reducing cost
·
Going Rate Pricing
o
Product is priced as per the rates prevailing
in the market especially on par with the competitors
o
It helps to avoid price wars
o
Most of the motor bike companies followed the
price of Bajaj and brought out bike variants accordingly
o
It helps to control the cost of production
·
Product Line Pricing
o
A product line is a group of products
produced by a firm that are related either as a complement or substitute
o
The products may be physically same or
different but sold under different demand conditions which give the seller a
chance to charge different prices
o
It is based on the competitive situation and demand
elasticity’s of each product
·
Price Skimming
o
When a new product is introduced in the
market, the firm fixes a price much higher than the cost of production in
absence of the competitors
o
Consumers
are ready to pay a high price to enjoy the pleasure of being the first users of
the product
o
After certain time, it will gain a huge
profit as well
·
Penetration Pricing
o
The price fixed is relatively a low one
o
It is adopted when the new product faces a
strong competition from the existing substitute products
o
The new firm has to penetrate the market, so
it will charge only a very low price initially, hoping to charge a normal price
later when it is established in the market
o
The penetration price sometimes below the
cost of production
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