CH 2

1. CH 2 The Economics of Price Determination Kent B. Monroe (2007). Pricing: Making Profitable Decisions. 3rd Edition (Singapore: McGraw-Hill) .

2. 02 Chapter Objectives (P.26) • To summarize the traditional neoclassical economic theory of price determination • To introduce some useful concepts for actual pricing decisions such as revenue, elasticity, marginal revenue, marginal costs etc.

3. 03 Price Determination Theory (P.26-27) • Minimize input cost • Maximize profit Economic theory is more concerned with the behavior of aggregates or markets, particularly how persistent and widespread behavior leads to stable results called “Equilibrium”. The firm

4. 04 Price Determination Theory (P.26-27) • Economic Perspective • The firm is a pricetaker, not the pricemaker • Management determines the quantity to • produce • The market sets price through the forces of • supply and demand • Marketing Perspective • Price is a decision variable.

5. 05 The Profit-Maximizing Firm (P. 28) $ Revenues or Costs Total Costs Maximum Profits Total Revenue Price Fixed costs Units 0 Q1 Q* Q Figure 2.1Output Determination for Profit-Maximizing Firm – Short Run (Constant Prices) : Aggregate Analysis

6. 06 The Profit-Maximizing Firm (P. 28) $ Costs Marginal cost Average cost Price (Marginal revenue) Units 0 Q* Q Figure 2.2Output Determination for Profit-Maximizing Firm – Short Run (Constant Prices) : Marginal Analysis

7. 07 The Profit-Maximizing Firm (P. 29) $ Price Marginal cost P* Demand (Marginal revenue) Units 0 Q* Q Figure 2.3Output Determination for Profit-Maximizing Firm – Short Run (Varying Prices)

8. 10 Corporate and Pricing Objective (P. 30) Pricing objectives should be consistent with & should advance corporate & marketing objectives Overall corporate objectives must be considered. The organization’s specific marketing objectives are based on those corporate objectives. Setting objectives for one element of the marketing mix.

9. 11 3 Classifications of Pricing Objectives (P. 30) COMPETITIVE Objectives PROFITABILITY Objectives VOLUME-BASED Objectives

10. 12 Profitability Objectives (P. 30) • Realizing maximum profits in the business. • Pricing objectives need to be measured precisely in order to be able to assess performance • Profitability objectives are measured and expressed in specific $or % • $1.1 million for 3 years • 10% increase in revenue before tax, etc.

11. 13 Elements of Profitability (P. 30-31) Monetary sales mix Qi Pi VCi Pi = Price per unit of each product or service offering. VCi = Variable costs per unit of each offering. FC = Fixed costs per period. Qi = Volume produced and sold of each offering. Monetary sales mix of the offering sold. FC

12. 14 Profit Maximization (P. 31) Depending on the marketing situation, maximum profits over a planning period may be obtained by either pricing the firm’s offerings relatively low or relatively high. Which pricing strategy to follow if you want to maximize profit? Depending on the nature of market demand and competition.

13. 15 Target Return on Investment (P. 31) WHAT DO THEY INVEST ON ? • The ratio of profits to investments • An ROI objective can be expressed • as a specific % of the investment • A variation is target return on sales Example A firm with $10 million in capital assets, seeking a 15% ROI, would seek to achieve net contribution to profits of___________for the planning period. $1.5 million

14. 16 Volume-Based Objectives (P. 32) Sales Volume • Revenue (sales) growth - prices are set • to demand and unit sales. • Market share - prices are set to sales • faster than competition; or to a sales decline • to be slower than competition. Customer Demand Creation

15. 17 Competitive Objectives (P. 32) Price stability- as amarket leader, the firm attempts to keep prices from declining (usually found in maturemarkets); usually leads to non-price competition. Aggressive pricing- price below competition to take advantage of market changes, when market demand is growing, or when opportunities to grow market share.

16. 18 Establishing Relevant Pricing Objectives (P. 33-34)

17. 19 Summary (P. 34) • There is no one apparent pricing objective for a specific set of market conditions. • A profitability objective does not specify either a high- or low- price strategy. • Using low price to pursue a volume objective must be viewed as an investment over several years. • The significance of being the low-cost supplier is … • it allows the firm to invest in non-price marketing efforts. • it is not a license to use price as a key competitive tool.

18. 20 Seat Work 1 (P. 35) Read the case given at Box 2.1 and answer the questions carefully. What was Boeing Pricing Objective in the beginning of the case? 2. What was the result of their change in pricing objective? 3. How did they resolve the losses incurred to Boeing in 1997? 4. What is Boeing’s current pricing objective?

19. 21 Market Structure : Degree of Competition (P. 35) Depending on the structure of competitors within a market, firms may have considerable discretion to determine prices. Table 2.1 Characteristics of Market Structure • Perfect (Pure) Monopoly • Perfect (Pure) Competition • Imperfect Competition • Monopolistic Competition • Oligopoly

20. 22 Market Structure : Degree of Competition (P. 36) Perfect Monopoly ตลาดผูกขาดแท้จริง • Only one seller supplies the product or service • Considerable degree of power over price/Government regulations

21. 23 Market Structure : Degree of Competition (P. 36) Perfect Competitionตลาดแข่งขันสมบูรณ์ • Many sellers offer many buyers an identical (homogeneous) product; • no seller can influence price

22. 24 Market Structure : Degree of Competition (P. 36) Imperfect Competitionตลาดแข่งขันไม่สมบูรณ์ • Large number of sellers and buyers • Few sellers, some sellers may hold relatively • large market shares and thus be able to influence the prices • of products they sell. • Monopolistic Competition • Oligopoly Year 2008

23. 25 Market Structure : Degree of Competition (P. 37) Monopolistic Competitionตลาดกึ่งแข่งขัน กึ่งผูกขาด • Large number of firms market heterogeneous (dissimilar) products • The greater the degree of product differentiation perceived by buyers, • the greater is the opportunity for competing firms to set different prices

24. 26 Market Structure : Degree of Competition (P. 37) Oligopolyตลาดผู้ขายน้อยราย • Few sellers dominate the marketplace and thus have substantial influence • over price. • The greater the degree of product differentiation perceived by buyers, • the greater is the opportunity for competing firms to set different prices

25. 27 The Laws of Supply and Demand (P. 38) Whether one, a few, or many sellers are operating in marketplace, their pricing decisions are influenced to some degree by the economic laws affecting supplyand demand.

26. 28 The Laws of Demand (P. 38) • Demand is a relation among various amounts of a product that buyers would be willing and able to purchase at possible alternative prices during a given time, all other things remaining the same • If supply is held constant… • an increase in demand leads to and increased market price, • a decrease in demand leads to a decreased market price.

27. 29 Factors Affecting Laws of Demand • Price • Income of households • Price and availability of substitute goods • Price and availability of complement goods • Expectations about future prices • The size and composition of the population

28. 30 The Laws of Supply (P. 38) • Supply is a relation showing the various amounts of a product that a seller would make available for sale at possible alternative prices during a given period of time, all other things remaining the same • When the price of a good is raised, more will be produced • If demand is held constant… • an increase in supply leads to a decreased in price. • a decrease in supply leads to an increased price.

29. 31 Equilibrium (P. 39) • In well-behaved markets, the supply and demand curves will intersect at some point. • An equilibrium between supply and demand is established, producing an equilibrium price • The market price at which the supply of an item equals the quantity demanded.

30. 32 Price Elasticity of Demand (P. 43) Price elasticity of demand measures the responsiveness of the quantity demanded for a product or service to a change in the price of the product or service Ed = price elasticity of demand ΔQ = quantity change in demand ΔP = quantity change in demand Q1, P1 = original quantity demanded and price, respectively

31. 33 Income Elasticity of Demand (P. 44) • Income elasticity of demand: responsiveness of the quantity demanded of a product or service to a change in personal income • If EI is negative, the product is an inferior good •  Income goes up fewer units are demanded (switch to steak, less hamburger) • If EIis positive, the product is a normal good •  Demand increases as income increases • If 0<EI<1, the product becomes less important in households’ consumption plan • If EI >1, the product becomes more important as income increases.

32. 34 Cross-Price Elasticity of Demand (P. 45) • Cross price elasticity of demand: responsiveness of demand for a product to a change in the price of another product • If EC is negative, the two products are complementary • If ECis positive, the two products aresubstitutes

33. 35 Consumers’ Surplus (P. 50) • The difference between the maximum amount consumers are willing to pay for a product (known as the reservation price) and the amount they actually pay

34. 36 Sellers’ Surplus (P. 51) • The seller also enjoys a sellers' surplus, which we may define as the difference between his minimum price and the market price.

35. 37 END OF CHAPTER II