MANAGERIAL ECONOMICS » MARGINAL COST PRICING

MANAGERIAL ECONOMICS » MARGINAL COST PRICING

1. MANAGERIAL ECONOMICS»MARGINALCOSTPRICING
IncaseofMarginalCostPricingwehavetoconsidertheincrementalcostof
production.Fixedcostisnottakenintoconsideration.Marginalcostistheadditional
costforproducingadditionalunitofoutput.Inthismethodthepriceisrelatedto
marginalcost.
ThemaindifferencebetweenFullCost
PricingandMarginalCostPricingisthatinMarginalCostPricingthefixedcost
componentisnotincluded.TheMarginalCostPricingisusefulintheshortperiod
whereasFullCostPricingismainlyforthelongperiod.Aslongasthemarginalcostis
coveredthereisasortofguaranteethatthefirmwillnotshutdown.
AdvantagesofMarginalCostPricing
1.Variablecostremainsconstantperunitofoutputandfixedcostsremainconstant
intotalduringshortperiod.Thuscontrolovercostsbecomesmoreeffectiveand
easier.Standardscanbesetforvariablecosts,whileBudgetscanbeestablished
forfixedcostinordertoexercisefullcontroloverthetotalactivities.
2.Marginalcostingbringsoutcontributionorprofitmarginperunitofoutput,and
clearlybringsouttheeffectofchangeinactivity.Itfacilitatesmakingpolicy
decisionsinanumberofmanagementproblems,suchasdeterminingprofitability
ofproducts,introducinganewproduct,discontinuingaproduct,fixingsellingprice,
decidingwhethertomakeorbuy,utilisingsparecapacity,profit-planning,etc.
3.Thedistinctionbetweenproductcostandperiodcosthelpseasyunderstandingof
marginalcoststatements.

2. 4.Closinginventoryofwork-in-progressandfinishedgoodsarevaluedatmarginal
orvariablecostonly.Thismethodleadstogreateraccuracyinarrivingatprofitas
iteliminatesanycarryoveroffixedcostsofthepreviousperiodthroughinventory
valuation.
5.Asacorollarytoabove,sincefixedcostsdonotenterintoproduct-cost,it
eliminatestheprocessofallocating,apportioningandabsorbingoverheads,and
adjustingunderandover-absorbedoverheads.Therefore,themethodissimplerto
operate.
ThefirmgenerallyfollowsMarginalCostPricingwhenitentersintoanew
market;thefirmhavingunutilizedcapacityandthatthereishighdegreeof
competitioninthemarket.
LimitationsofMarginalCostPricing
1.Thispolicyisusefulonlyintheshort-periodanddoesnotprovidealong-runstable
pricepolicy.
2.Underincreasingcostconditionsitmayleadtohigherpriceandunderdecreasing
costconditionsitwillleadtolowerprice.
3.Itmayleadtofrequentpricechangeswhicharenotlikedbytheconsumers.The
buyerspreferstablepricesandnoterraticpricefluctuations.
ItneedstobenotedthattheMarginalCostPricingprovidestheupperand
lowerlimitsofpriceswhereasFullCostPricingclingstothemiddlepoints.Infact
whilefixingthepriceboththetheoriesshouldbetakenintoaccountasboththe
systemsofpricingreinforceeachother.
NB:FullCostPricing:Inthismethodtheproducercalculatesperunitcostof
productionandaddsamarginofprofittoit,whichheconsidersfairandthereby
arrivesatapricewhichisacceptabletotheconsumer.Infixingtheprice,thefirm
calculatestheaveragevariablecost,addstoittheaveragefixedcostandtothatadds
theamountoffairprofit.Fairprofitisnormallytakenas10%to15%ofthecost.