Page 230 - DECO101_MICRO_ECONOMICS_ENGLISH

Unit 14: Pricing Decisions

5. The prevalence of multi-product, multi-process and multi-market concerns makes the Notes

absorption of fixed costs into product costs absurd.
6. In many businesses, the dominant force is innovation combined with constant scientifi c
and technological development and the long-run situation is often highly unpredictable.

Disadvantages of Marginal Cost Pricing

1. Some accountants are not fully conversant with the marginal cost techniques themselves,
and are not, therefore, capable of explaining their use to management.
2. In a period of business recession, firms using marginal cost pricing may lower prices in

order to maintain business and this may lead other firms to reduce their prices leading to

cut-throat competition.
3. With the existence of idle capacity and the pressure of fi xed costs, firms may successively

cut down prices to a point at which no one is earning sufficient total contribution to cover

its fixed costs and earn a fair return on capital employed.
4. In spite of its advantages, due to its inherent weakness of not ensuring the coverage of

fixed costs, marginal cost pricing has usually been confined to pricing decisions relating to

special orders.
Business situations requiring the use of marginal costing include situations where price is the
primary determinant of an offer; where initial product acceptance is being sought to facilitate
entry into a new market; where the product is being targeted to a low quality market segment;
where price competition is intense, and when the price responsiveness of demand is high i.e. a
little reduction in price may lead to a substantial increase in volume.

Case Study Real World: Changes Required in the Simple Cost-plus
Pricing Method

any manufacturers base their prices on direct costs, adding an arbitrary
percentage to cover overheads. In theory, such an approach will produce profi ts,
Mbut it can also price a product out of the market or lead to an overproduction of

less profitable items at the expense of more profi table ones.
The reason for this apparent contradiction is that traditional pricing methods often fail to
consider the following essential factors:
1. The price of competing products;
2. The need for the maximum loading of production facilities throughout the year or an
optimum utilisation of the plant and equipment at any given point of time;
3. The “restraining factors”.
The shortcomings of the traditional pricing system can be illustrated best by an actual
example. Let us assume that a manufacturer has, in his collection, two fabric designs made
from the same yarn and that supplies of this raw material during a particular season are
limited.

Now, the customers show keen interest in both fabrics, and the marketer knows that he
will not have enough yarn to meet all the orders. He will need to decide the product mix

Contd...

LOVELY PROFESSIONAL UNIVERSITY 225