Unit 11:

Question 1

What is the law of demand?

Answer 1

The law of demand states that if all other factors are held constant, the price of a product and the quantity demanded are inversely (negatively) related. The higher the price, the lower the quantity demanded.

Question 2

Describe the price elasticity of demand.

Answer 2

The price elasticity of demand (Ed) measures the sensitivity of the quantity demanded of a product to a change in its price. It describes the reaction to a change in price from one level to another and can be calculated using either the general formula or the midpoint formula.

Question 3

When the demand elasticity coefficient is greater than one, demand is

Answer 3

In a relatively elastic range. A small change in price results in a significant change in quantity demanded.

Question 4

When the demand elasticity coefficient is equal to one, demand has

Answer 4

Unitary elasticity (usually a very limited range). A single-unit change in price brings about a single-unit change in quantity demanded.

Question 5

When the demand elasticity coefficient is less than one, demand is

Answer 5

In a relatively inelastic range. A large change in price results in an insignificant change in quantity demanded.

Question 6

When the demand elasticity coefficient is infinite, demand is

Answer 6

Perfectly elastic (depicted as a horizontal line). In pure competition, the number of firms is so great that one firm cannot influence the market price.

Question 7

When the demand elasticity coefficient is equal to zero, demand is

Answer 7

Perfectly inelastic (depicted as a vertical line). Some consumers’ need for a certain product is so high that they will pay whatever price the market sets. The number of these consumers is limited and the amount they desire is relatively fixed.

Question 8

Describe pure competition.

Answer 8

A purely competitive market is characterized by a large number of buyers and sellers acting independently and a homogeneous or standardized product. Marginal revenue equals price.

Question 9

Describe a monopoly.

Answer 9

In a monopoly market, the industry consists of one firm and the product has no close substitutes. Marginal revenue is less than price. To increase sales of its product, a monopolist generally must lower its price. Thus, marginal revenue continuously decreases as output increases.

Question 10

Describe monopolistic competition.

Answer 10

An industry in monopolistic competition has a large number of firms that produce differentiated products. The number is fewer than in pure competition, but it is great enough that firms cannot collude. That is, they cannot act together to restrict output and fix the price. Products can be differentiated on a basis other than price such as quality, brands, and styles.

Question 11

Describe an oligopoly.

Answer 11

An oligopoly is an industry with a few large firms. Firms operating in an oligopoly are mutually aware and mutually interdependent. Their decisions as to price, advertising, etc., are, to a very large extent, dependent on the actions of the other firms. Each firm sets price and production levels after considering mutual interdependence. Price tends to be rigid because of the interdependence among firms.

Question 12

Describe market-based (buyer-based) pricing.

Answer 12

Market-based pricing starts with a target price and involves basing prices on the product’s perceived value and competitors’ actions rather than on the seller’s cost. Market-based pricing is typical when there are many competitors and the product is undifferentiated.

Question 13

Describe competition-based pricing.

Answer 13

Competition-based pricing involves going-rate pricing, which bases price largely on competitors’ prices, and sealed-bid pricing, which bases price on a company’s perception of its competitors’ prices.

Question 14

Describe new product pricing.

Answer 14

New product pricing involves price skimming and penetration pricing. Price skimming is the practice of setting an introductory price relatively high to attract buyers who are not concerned about price and to recover research and development costs. Penetration pricing is the practice of setting an introductory price relatively low to gain deep market penetration quickly.

Question 15

Describe cost-based pricing.

Answer 15

Cost-based pricing begins with a cost determination followed by setting a price that will recover the value chain costs and provide the desired return on investment (i.e., the cost-plus target rate of return).

Question 16

Describe target pricing.

Answer 16

A target price is the expected market price for a product or service, given the company’s knowledge of its consumers’ perceptions of value and competitors’ responses.

Question 17

What is the product life cycle?

Answer 17

The product life cycle is the cycle through which every product goes from introduction to withdrawal or eventual demise.
This cycle has five stages:

Precommercialization
Introduction
Growth
Maturity
Decline

Question 18

What is life-cycle costing?

Answer 18

Life-cycle costing estimates a product’s revenues and expenses over its expected life cycle. The result is to highlight upstream and downstream costs in the cost planning process that often receive insufficient attention. Emphasis is on the need to price products to cover all costs, not just production costs.

Question 19

What is the purpose of the federal Robinson-Patman Act of 1936?

Answer 19

The Robinson-Patman Act of 1936 makes discriminatory pricing among customers illegal if it has the effect of lessening competition, although price discrimination may be permissible if the competitive situation requires it and if the costs of serving some customers are lower. Moreover, the act applies to buyers as well as sellers. A buyer may not knowingly accept a price that is so low as to be discriminatory.