Appendix A: Pricing products and services. In this appendix, we are concerned with the more common situation in which a business is faced with the problem of setting its own prices. Clearly, the pricing decision can be critical. If the price is set too high, customers won’t buy the company’s products. If the price is set too low, the company’s costs won’t be covered. | Pricing Products and Services Appendix A The Economists’ Approach to Pricing Elasticity of Demand The price elasticity of demand measures the degree to which the unit sales of a product or service are affected by a change in unit price. Change in Price versus Change in Unit Sales Price Elasticity of Demand Demand for a product is inelastic if a change in price has little effect on the number of units sold. Example The demand for designer perfumes sold at cosmetic counters in department stores is relatively inelastic. Price Elasticity of Demand Demand for a product is elastic if a change in price has a substantial effect on the number of units sold. Example The demand for gasoline is relatively elastic because if a gas station raises its price, unit sales will drop as customers seek lower prices elsewhere. Price Elasticity of Demand As a manager, you should set higher (lower) markups over cost when demand is inelastic (elastic). Price Elasticity of Demand Єd = ln(1 + % change in . | Pricing Products and Services Appendix A The Economists’ Approach to Pricing Elasticity of Demand The price elasticity of demand measures the degree to which the unit sales of a product or service are affected by a change in unit price. Change in Price versus Change in Unit Sales Price Elasticity of Demand Demand for a product is inelastic if a change in price has little effect on the number of units sold. Example The demand for designer perfumes sold at cosmetic counters in department stores is relatively inelastic. Price Elasticity of Demand Demand for a product is elastic if a change in price has a substantial effect on the number of units sold. Example The demand for gasoline is relatively elastic because if a gas station raises its price, unit sales will drop as customers seek lower prices elsewhere. Price Elasticity of Demand As a manager, you should set higher (lower) markups over cost when demand is inelastic (elastic). Price Elasticity of Demand Єd = ln(1 + % change in quantity sold) ln(1 + % change in price) Natural log function Price elasticity of demand I can estimate the price elasticity of demand for a product or service using the above formula. The Profit-Maximizing Price -1 Profit-maximizing markup on variable cost 1 + Єd = Under certain conditions, the profit-maximizing price can be determined using the following formula: Using the above markup, the selling price would be set using the formula: Profit-maximizing price -1 1 + Єd Variable cost per unit = 1 + × The Profit-Maximizing Price This graph depicts how the profit-maximizing markup is generally affected by how sensitive unit sales are to price. The Cost Base Under the absorption approach to cost-plus pricing, the cost base is the absorption costing unit product cost rather than the variable cost. The cost base includes direct materials, direct labor, and variable and fixed manufacturing overhead. Setting a Target Selling Price Here is information provided by the management of Ritter .
