Pricing on Economic Theory

Dynamics of the marketplace

The constant state of flux experienced in any given market is a result of heterogeneity to be found in both buyer demand and seller supply.Buyer demand changes heterogeneously due to:Some buyers being faster learners than othersGreater product interest in usage variancesSome buyers having more discretionary income

Dynamics of the marketplace

The heterogeneous changes in supply arisefrom: Some sellers learning faster Some having more resources Some prepared to take greater risks

DemandIn economics, demand is the desire to own anything, the ability to pay for it, and the willingness to pay.

The term demand signifies the ability or the willingness to buy a particular commodity at a given point of time.

So demand has a relationship with price.

This relationship is inverse or indirect because as price gets higher, people want less of a particular product. It has given it a special name: the law of demand.

There are various ways to express the relationship between price and the quantity that people will buy. Mathematically, one can say that quantity demanded is a function of price, with other factors held constant, or:Qd = f(Price, other factors held constant)

Inverse relationship with price

Relationship with PriceA Demand Curve

Price ofWidgets

Number of WidgetsPeople Want to Buy

$1.00 100

$2.00 90

$3.00 70

$4.00 40

Elasticity of Demand

Responsiveness of the demand for a good or service to the increase or decrease in its price.

Normally, sales increase with drop in prices and decrease with rise in prices.

As a general rule, appliances, cars, confectionary and other non-essentials show elasticity of demand whereas most necessities (food, medicine, basic clothing) show inelasticity of demand.

Formula for Elasticity of Demand

Relative change(%) in quantity demanded

Relative change in price (%)Ed=

% Q% P

Ed=

SupplyA fundamental economic concept that describes the total amount of a specific good or service that is available to consumers.

This relates closely to the demand for a good or service at a specific price; all else being equal, the supply provided by producers will rise if the price rises because all firms look to maximize profits.

Supply, Demand and Market Equilibrium

Pricing in Market-oriented Economy

A market oriented economy can be defined as an economy where the market plays the “invisible hand” (Adam Smith-Wealth of Nations, 1776) in producing and distributing resources efficiently in a system.

It brings about the highest levels of productive efficiency.

The essential feature of the market economy is the decision of the market to determine what to produce, for whom to produce and there is a private ownership over the means of production.

Production and consumption decisions are taken according to the forces of the market; namely demand and supply.

Role Of Cost In Pricing

Impact of costs on pricing

Company take pricing decisions based on global completion and cost effective way so that the company will obtain its marketing objectives.

The cost of producing product and service are high, then the price of particular product and Service will be high.

Because of competitive environments, business organizational structures, and market response have changed dramatically, therefore the pricing decisions of the company are more complex and dynamic.

Cost structure pricing

Cost structures are simply the identification of how costs associated with the production of a good or service is distributed throughout the process.

This can include costs such as labor and utilities, as well as back end costs like sales and marketing expenses.

Allocation of costs

Cost allocation is the assigning of a common cost to several cost objects. For example, a company might allocate or assign the cost of an expensive computer system to the three main areas of the company that use the system.

Some people describe the allocation as the spreading of cost, because of the arbitrary nature of the allocation.

The goal is to allocate or assign the costs based on the root causes of the common costs instead of merely spreading the costs.

Forecasting costs

A financial forecast is normally an estimate of future financial outcomes for company or country (for futures and currency markets).

Using historical internal accounting and sales data, in addition to external market and economic indicators, a financial forecast is an economist's best guess of what will happen to a company in financial terms over a given time period -- which is usually one year.

Forecasting costs

It has three steps……..1st• Determination relative

positions of the cost category

2nd • Forecast the relative changes in the relative cost positioning

3rd• Forecast the extent change

within each of the respective categories

Cost concepts

Costs are the total spent for goods or services including money and time and labor.

In business, retail, and accounting, a cost is the value of money that has been used up to produce something, and hence is not available for use anymore.

In economics, a cost is an alternative that is given up as a result of a decision.

Fixed costs & Variable costs

Fixed costsCosts that do not vary with production or sales level.For example- a company must pay each month’s bills for rent, heat, interest and executive salaries, whatever the company’s output.

Variable costs Costs that vary directly with the level of production.

An example is the materials and components that enter into each unit produced.

Incremental costsThis is an increase in either fixed costs or variable costs as a result of a managerial decision to change an existing policy or to add a new piece of equipment or installed a new programmed.

Incremental costs also called managerial costs.

Economies Associated With Volume

In this section three concepts should be considered:

CapacityScaleExperience

Mainly this represents the association of volume effecting the economic decisions.

Economies of ScopeAn economic theory stating that the average total cost of production decreases as a result of increasing the number of different goods produced.

For example, McDonalds can produce both hamburgers and French fries at a lower average cost than what it would cost two separate firms to produce the same goods. This is because McDonalds hamburgers and French fries share the use of food storage, preparation facilities, and so forth during production.

Core LinkagesThe relationship between activities where the way one is performed materially impacts the cost of performing the other.

For example, the purchase of a higher-quality processed material may reduce both processing time and scrap to the extent that overall total costs are reduced.

Out sourcing and BalancingOutsourcing is contracting with another company or person to do a particular function.

A variation of outsourcing is the shifting of the inventory management function to suppliers. Instead , of reacting to purchase orders, suppliers make shipments based on demand information supplied them by their customer.

For example, Wal- Mart no longer has the responsibility to manage its own inventory. Instead, suppliers such as Procter & Gamble ship on the basis of information supplied to them of their product