Flashcards in Pricing Deck (29)
What is Price Elasticity of Demand?
It is the measure of responsiveness in the level of quantity demanded to a change in price.
What is the formula for calculating Price Elasticity of Demand?
PED = % Change in Quantity Demanded / % Change in Price
When PED > 1 is demand elastic or inelastic?
What does elastic demand mean?
A small change in price will cause a proportionally greater change in the quantity demanded.
When PED < 1 , is demand elastic or inelastic?
What does inelastic demand mean?
Changes in price of a product do not create large changes in demand.
What is the formula of the demand function?
P = a - bQ
Explain each of the elements of the demand function: P = a -bQ
P = seling price
Q = quantity demanded at that price
a = maximum theoretical price (y intercept)
b = gradient of demand line*
*where b = change in price / change in quantity
How is inelastic demand shown graphically?
Steeper demand curve
How is elastic demand shown graphically?
Shallower demand curve
What is the optimal price?
The level of output at which profit is maximised.
What is the formula to derive the optimal price / profit maximisation?
Marginal Revenue = Marginal Cost
At which point is revenue maximised?
Where Marginal Revenue = 0
What is the formula for marginal revenue?
MR = a - 2bQ
What is the gradient of the Total Revenue line also known as?
What is the gradient of the Total Cost curve also known as?
What is marginal revenue?
The additional revenue gained as a result of selling one more unit.
What is marginal cost?
The additional cost incurred as a result of producing one more unit.
How would we derive the profit maximising price?
1. Derive the demand function
2. Derive the profit maximising quantity (MR = VC)
3. Sub quantity back into the demand function to find the price.
What is the Total Cost Function?
Y = a + bx
What are the four cost plus pricing strategies?
Full Cost (absorption)
What are the three benefits of cost plus pricing?
- easy to calculate
- readily determined
- doesn't require a linear and stable price/quantity relationship.
What are the three disadvantages of cost plus pricing?
- Ignores demand and competitors
- Price may need to be adjusted to reflect market conditions
- If basis for absorbing overheads changes then product price will change so absorbtion costing methods require accurate calculations.
What are the two pricing strategies for New Products?
What is market penetration?
A policy of low prices when the product is launched in order to obtain sales volume and market share.
Quickly hits the growth stage but may incur initial loss in using this strategy to get people interested.
What is market penetration useful for?
- discouraging new entrants to the market
- shortening the initial period of the products
- achieving significant economies of scale
What is market skimming?
Policy of charging high prices when the product is first launched in order to try to recover development costs quickly and gain high unit profits early in the products life.
When is it useful to use market skimming?
- when a product is new and different and customers are willing to pay high prices to be the first ones with the product (iphones)
- Product has short life cycle so need to recover development costs and make profits quickly.