Pricing strategy, demand and supply.pptx

notes on demand and supply and pricing strategy

1. Pricing Economics Pricing Methodologies

2. Demand Demand is an economic concept that relates to a consumer's desire to purchase goods and services and willingness to pay a specific price for them.

3. Law of demand The law of demand states that the price of a product or service is inversely (that is, negatively) related to the quantity demanded. As the price declines, the quantity demanded increases; as the price increases, the quantity demanded declines. Demand is represented on a graph as a downward sloping line.

4. Exceptions to the Law of Demand Veblen Goods: They become more valuable with their price rise. These are the goods people consider to be more useful with an increase in Price. Like a high-priced gold necklace, it's more desirable to the customer than the one with lower costs. A cell phone model with a high cost has more demand in the market. Price Change Exception : The issue of price change in the market is another exception to the law of Demand. There might be a situation when the Price of a product or service increases and is subjected to future growth. So, the customers may buy more of it to avoid further cost increment. Eventually, there are times when the Price of a product is about to decrease. Consumers may temporarily stop the purchase to avail of the future benefits of price decrement.

5. Necessary Goods: People can’t stop purchasing the products of regular necessities. For example, if the cost of salt increases, consumers won't be able to afford it. It is the complete opposite of the law of Demand Luxury Goods : A significant exception to the law is the Demand for luxury goods. In such cases, even if the price increases, the consumer won't stop consumption. Cigarettes and alcohol typically come in this category. Income Change : The change in income of a consumer or a family also determines the Demand for a particular product. If a family's income increases, they may choose to buy a specific product in more quantity, no matter the Price. Again, if the family's income decreases, they can select to reduce product consumption to an extent. It opposes the law of Demand. 

6. Shift in Demand Meaning Shift in demand  represents a change in the quantity of a product or service that consumers seek at any price point, caused or influenced by a change in economic factors other than price. The demand curve shifts when the quantity of a product or service demanded at each price level changes. If the quantity demanded at each price level increases, the demand curve shifts rightward. Inversely, if the quantity demanded at each price level decreases, the demand curve will shift leftward.

7. Supply It represents the total amount of certain goods available to consumers. Supply of a product tends to increase if a price goes up because companies want to expand their production to meet the increasing demand.

8. Law of supply The law of supply states that, in the short run, the price of a good or service and the quantity supplied are positively correlated. As the price of a good or service increases, producers are willing to supply more of it to the market, causing an increase in the total quantity supplied. Similarly, as the price of the good or service decreases, producers are willing to supply less of it to the market because of the lower selling price and thus lower profits. As prices fall, the total quantity supplied to the market decreases. The law of supply is represented graphically as an upward-sloping line, as shown on the graph that follows.

9. Exemptions to law of supply When price is expect to fall further When seller is in need for cash

10. Market equilibrium Market equilibrium is the point where the demand curve intersects with the supply curve. This intersection determines the equilibrium market price and equilibrium quantity exchanged of a good or service because at this point of intersection the market price (or the “equilibrium price”) is such that the quantity demanded by consumers is exactly equal to the quantity supplied by firms

11. • Any price above the equilibrium price in a market is unstable because the quantity supplied to the market exceeds the quantity demanded. Excess supply exerts pressure for firms to reduce the price in order to sell more, so the price will fall. • Any price below the equilibrium price in a market is unstable because the quantity demanded in the market exceeds the quantity supplied. Excess demand exerts upward pressure on the price because consumers are willing to pay more in order to get what they want or need, so the price will rise

12. Price elasticity of demand The price elasticity of the demand for a particular product or service will determine how much effect a price increase or decrease will have on the quantity demanded of that product or service. EoD = Change in Quantity/Avg Quantity / Change in Price/Avg Price

13. Assume the following information for two points along the demand curve: Point A: Price = $4; Quantity = 120 Point B: Price = $5; Quantity = 80 When the price change is from $4 to $5, the calculation of elasticity using the midpoint method. The price of bananas is $1.50 per pound, and at that price, 1,500 pounds are sold. The price of bananas falls to $1.41 per pound, and the quantity sold increases to 1,680 pounds. The price elasticity of demand for bananas using the Midpoint Method The price of bread is $2.00 per loaf, and at that price, 2,500 loaves are sold. The price decreases to $1.60 per loaf, and the quantity sold increases to 2,625 loaves. The price elasticity of demand for bread using the Midpoint Method is

14. Classification of elasticity of demand

15. Types of market Perfect Competition : Pricing decisions for a firm in a perfectly competitive market are easy: the perfectly competitive firm is a price taker and sells at the market price. However, perfect competition is a theoretical market structure, since no perfectly competitive market exists. Monopoly Market : A monopoly market is the one where a firm is the sole seller of a product without any close substitutes. In a monopoly market structure, a single firm or a group of firms can combine to gain control over the supply of any product. The seller does not face any competition in such a market structure as he or she is the sole seller of that particular product.  No other firm produces a similar product, and the product is unique. It does not face much cross elasticity of demand with all other products.

16. Monopolistic Competition: Monopolistic competition is a market structure characterized by a large number of firms that sell similar but not identical products. In this type of market, each firm has some degree of market power, meaning they can influence the price of their product by adjusting the quantity they supply. However, because there are many firms selling slightly different products, none of them has complete control over the market. The entry and exit barrier for the firms in the monopolistic market is very low. In a monopolistically competitive market, firms often engage in product differentiation, which means they try to make their product stand out from competitors by offering unique features or benefits. This can include things like branding, packaging, and marketing. Monopolistic competition is often found in industries such as restaurants, clothing, and personal care products. Oligopoly: An oligopoly is a type of market structure in which a small number of firms control the market. Where oligopolies exists, producers can indirectly or directly restrict output or prices to achieve higher returns. A key characteristic of an oligopoly is that no one firm can keep the others from having significant influence over the market. Oligopolies in history include steel manufacturers, oil companies, railroads, tire manufacturing, grocery store chains, and wireless carriers.

17. Short-run profit maximization in perfect competition The short-run equilibrium price for a firm in a perfectly competitive market is the market price. Because the firm is a price taker, its price is also its average revenue as well as its marginal revenue. The perfectly competitive firm does not need to drop its price to sell more because it can sell as much as it wants to at the market price. Since a firm in a perfectly competitive market wants to maximize its profits, it will produce at the level where its marginal cost of production is equal to the marginal revenue.

18. Short-run profit maximization in monopoly competition Monopolies determine the quantity to produce in the same manner as firms in perfect competition: they will produce as many units as they can sell until the marginal cost of production exceeds the marginal revenue from selling one more unit. Monopoly quantity is determined at the point where MR=MC. Price determination is done differently for a monopoly than for a firm in perfect competition. For the perfectly competitive firm, the price is set by the market and the individual firm cannot change it. In contrast, the monopolistic firm is able to influence the price. The marginal revenue curve (MR) is below the demand curve because, as production increases, a monopolist that charges the same price for all of its output will have to lower its price in order to get consumers to buy the increased output. Therefore, the additional (that is, marginal) revenue received from producing an additional unit will be less than the price received for that unit. The economic profit for the monopoly firm will be same as in short run and long run, other firm’s economic profit in long run will decrease as the competition increases. There is no competition for a monopoly firm.

19. Short-run profit maximization in monopolistic competition In the short run, the monopolistically competitive firm maximizes its profit (or minimizes its loss) by producing at the level where its marginal revenue equals its marginal cost. In the short run, it realizes an economic profit. In the long run, other firms will enter the industry because of the economic profit potential and because barriers to entry are low. As the new firms enters the market, the old firms are forced to reduce the price which will decrease their accounting profit as well as economic profit, theoretically economic profit will fall to zero in long run for a monopolistic firm.

20. Short-run profit maximization in oligopoly competition In one theory of oligopoly, a price decrease by one company will usually be matched by others’ price decreases, but a price increase by one company will usually not be followed by the other companies. Thus, an oligopolist faces a demand curve that has distinctly elastic and inelastic sections. The curve is relatively elastic when prices increase, because the other firms will not follow a price increase and the firm will lose sales. Therefore, a small increase in price will lead to a large decrease in demand. Therefore, the oligopolist firm is unlikely to raise its prices. However, the curve is relatively inelastic when a firm decreases its price, because the other firms will match the price decrease. Therefore, the firm will need to make a large price decrease in order to gain any sales. Because the decrease in price will be larger than the increase in sales and the price decrease will lead to lower total revenue, a firm is unlikely to lower prices. Since either increasing or decreasing the price has a negative effect, prices in an oligopoly tend to be “sticky” (meaning that they do not change easily).

21. Pricing methodologies When setting a price for a product or service, management must consider internal and external factors, such as cost, competition, customer's perception, and company strategy. The price set by the company should be in a such a way that which is sufficient to cover all of its costs and affordable to every customers.

22. Pricing methods Cost Based Method Market Based Method Value Based Method (Customer Based Method)

23. Cost Based method In cost-based pricing, the company designs a product, figures out the total costs to make the product, and sets a price that covers its cost plus a factor for profit. Suppliers who provide unique products and services (such as construction companies and Professionals ) usually use cost-plus pricing. They are usually price makers. Under cost based method:- Selling price = Unit costs + Markup percentage

24. Generally there are 3 types of unit costs which we use in cost based pricing, they are:- Variable Cost Product Cost Total Cost The markup percentage which we use in cost based approach is based on the unit cost which we use to price the product. Markup percentage on Variable cost = (All costs other than variable costs + Desired Profit)/VC Markup percentage on Product Cost = (All non manufacturing costs + Desired Profit)/Product Cost Markup percentage on Total cost = Desired Profit/Total Cost

25. Calculate selling price on the basis of variable costs, product costs & total costs for the following data; DM 12 DL 10 VMOH 3 FMOH 2 V. Selling 5 F. Selling 3 Desired Profit 5

26. Calculate selling price on the basis of variable cots, product costs & total costs for the following data; DM 2 DL 1 VMOH 4 FMOH 2 V. Selling 1 F. Selling 3 Desired Profit 2

27. Market based pricing In the market-based pricing approach, the company sets prices according to demand and competitors’ actions and reactions. Companies operating in competitive markets use a market-based approach to setting prices because in this pricing environment products and services are very similar from company to company, so any one company has almost no influence over price levels. They are usually price takers. For market-based pricing, management begins with the market price for the product. Next, management determines whether or not it can produce and sell the product at a cost that will earn an adequate profit.

28. In market based pricing we start from the market price of the product. Then we will less the target profit which have been set by the management to get maximum allowable cost. Eg:- The market price for a product is 50. The desired profit set by the management is 10. The total costs of production when the company makes this product is 42. Calculate the maximum allowable cost and the cost reduction.

29. Value engineering If the estimated cost per unit that results from these calculations is greater than the target cost per unit, the company must reduce costs. One way to reduce costs is to seek cost concessions from suppliers. Another way is through value engineering. Value engineering is an evaluation of all the business functions in a product’s value chain with the objective of reducing costs while still satisfying customer needs. This evaluation may lead to design improvements, materials specification changes, or modifications to manufacturing methods. When performing value engineering, management distinguishes between a value-added cost and a nonvalue-added cost. If a value-added cost were eliminated, it would reduce the product’s value (or usefulness). Since value-added costs cannot be eliminated, value engineering seeks to reduce these costs by improving efficiency. On the other hand, elimination of a non-value-added cost would not reduce the value or utility of the product. A non-value-added cost is a cost the customer is not willing to pay for.

30. Value based method(Customer based method) Value-based pricing is a strategy of setting prices based primarily on a consumer’s perceived value of a product, rather than considering the cost of producing the item. Value based pricing is customer focused pricing. Companies that offer unique or highly valuable features or services are better positioned to take advantage of the value pricing model than are companies that sells commoditized items.

31. Price adjustment strategies Cash (or Sales) Discounts: A discount is offered to buyers who pay their invoices within a certain period. Volume Discount Pricing: Customers who purchase in large volumes are rewarded with a discounted price. Seasonal Discounts: Prices are reduced for products or services purchased out of season (that is, during a time frame when sales are generally lower than average).

32. New product pricing strategies Market Penetration Pricing: When a company wants to penetrate a market quickly and maximize its market share with a new product, it may set a low initial price with the expectation of high sales volume, lower per-unit costs, and higher long term profit. The goal is to win market share, stimulate market growth, and discourage competition. Market Skimming: A company unveiling a new technology may set a high initial price to “skim” the market by attracting purchasers who crave the “newest thing.” When the initial excitement passes, sales slow, and competitors enter the new market, the company might lower prices to attract the next group of price-sensitive customers. Prices then may drop again.

33. Product life cycle (plc) pricing & Costing Brands, products, and technologies all have life cycles. The product life cycle (PLC) is the time from a product’s initial research and development to the point when the company no longer offers customer servicing and support for it. Life-cycle costing tracks and accumulates all the costs of each product through the value chain. After considering the product’s life-cycle budgeted costs, management sets a price that will maximize lifecycle operating income. A company may decide to bring the new product out at an extremely high or extremely low price point and then adjust later.

34. Steps in plc Product development: During the development stage, R&D expenditures and costs for setting up production facilities and the marketing program are high. No sales are being made yet so there are no revenues. Introduction: Growth is slow and profits are minimal due to the heavy upfront costs to introduce a new product. Growth: If the introduction stage is successful, the product will experience rapid sales growth and increasing profits. Maturity: Sales growth usually slows and profits level off or decrease. The company needs to spend more for marketing to defend the product against the competition. Decline: Sales drop markedly and profits fall.