Chapter 7 - The pricing decision

Question 1

What does the price elasticity of demand measure?

Answer 1

Measures the change in demand as a result of a change in its price

Question 2

If the price elasticity of demand is above 1 what is it?

Answer 2

Demand is elastic

Question 3

If the price elasticity of demand is below 1 what is it?

Answer 3

Demand is inelastic

Question 4

What are the factors affecting price elasticity?

Answer 4

Scope of the market
Information within the market
Availability of substitutes
Complementary Products
Disposable income
Necessities
Habit

Question 5

What are the limitations of the profit-maximisation model?

Answer 5

Unlikely that org will be able to determine the demand function for their product or service with any degree of accuracy
Majority of orgs aim to achieve a target profit
Determining an accurate and reliable figure for marginal or variable cost poses difficulties for the management accountant
Unit marginal costs are likely to vary depending on the quantity sold

Question 6

What are the pros of total cost-plus pricing?

Answer 6

Quick and cheap, if cost structures are known
Useful in contracting industries
Required profit achieved if sales budgets are achieved
Useful to justify price increases

Question 7

What are the cons of total cost-plus pricing?

Answer 7

Can be the basis for uncompetitive prices
Ignores the price elasticity of demand
Problematic if budget sales volumes not achieved
Ignores competitors activities

Question 8

What are the pros of marginal cost-plus pricing?

Answer 8

Simple to operate
Draws management attention to contribution and the effects of higher or lower sales volumes on profit
Good for pricing specific contracts
Facilitates decision making when resources are scarce

Question 9

What are the cons of marginal cost-plus pricing?

Answer 9

Does not ensure that sufficient attention is paid to demand conditions, competitors prices and profit maximisation
Ignores fixed overheads in the pricing decision. Fixed costs may not be recovered in the long term
Difficult to raise prices when margins are low
May encourage price wars

Question 10

When can premium pricing be used?

Answer 10

Can only be done if the product appears ‘different’ and superior to competition.
Normally means establishing a brand name based on:
Quantity
Image/style
Reliability/robustness
Durability
After-sales services
Extended warranties

Question 11

What is market skimming?

Answer 11

High price is set for the product initially, so that only those who are desperately keen on the product will buy it.

Question 12

What is the aim of market skimming?

Answer 12

Maximise profit but on occasions it is also used to prolong the life of older products

Question 13

What does market skimming often require?

Answer 13

Heavy advertising

Question 14

What is penetration pricing?

Answer 14

company sets a very low price for the new product initially

Question 16

What are the benefits of penetration pricing?

Answer 16

Allows the company to get a foothold in the market
Shortens the early stages of the product lifecycle
Quick volume growth can lead to economies of scale

Question 17

What is price differentiation?

Answer 17

If market can be split into different segments, Possible to sell the same products to different customers at different prices

Question 18

What will market segmentation usually be based on?

Answer 18

Time
Quantity
Type of customer
Outlet/Function
Geographical location
Product content

Question 19

What is loss leader pricing?

Answer 19

Supplier set a relatively low price for the main product and a high one for the ‘extras’

Question 20

What is product bundling?

Answer 20

Putting a package of products together to make, for example, a complete kit for customers, which can then be sold at a temptingly low price

Question 21

What are the five stages in the product life cycle?

Answer 21

Development
Introduction
Growth
Maturity
Decline

Question 22

What are the features of introduction phase in the product life cycle?

Answer 22

Demand will be low when product is first launched
Heavy advertising expenditure

Question 23

What are the features of the growth stage in the product life cycle?

Answer 23

Steady and often rapid increase in demand
Cost per unit falls
Large market share
Most profitable stage for the initial supplier

Question 24

What are the features of the maturity stage in the product life cycle?

Answer 24

Increase in demand slows down
Sales curve flattens out and eventually begins to fall
Products have to be differentiated in order to maintain their position
Profits lower than during growth stage

Question 25

What are the features of the decline stage in the product life cycle?

Answer 25

Saturation point: sales curve begins to decline
Price wars erupt
Profit could still be made during this stage