AC114: Chapter 4 - Pricing Calculations

What is cost-based pricing?

Setting a price by adding a profit margin (mark up) to the cost of a product.

How do you calculate a sales price using cost-plus pricing?

Sales price = Cost + Mark-up (profit margin).

What is the difference between mark-up and margin?

Mark-up is profit as a % of cost. Margin is profit as a % of selling price.

What is the main criticism of full cost-plus pricing?

It ignores demand and what customers are willing to pay.

What is marginal cost-plus pricing?

Pricing using only the variable costs plus a profit.

Name one advantage of marginal cost pricing.

It is simple and focuses on costs that can be controlled in the short term.

Name one disadvantage of marginal cost pricing.

It ignores fixed costs, so may underprice a product.

What is a transfer price?

The price for a product sold to another part of the same company.

Give a simple example of a transfer price method.

Use variable cost only, full cost, or market price.

What does a shift in the demand curve mean?

People want more or less of a product at the same price.

Name a factor that can shift demand right (increase).

Higher income, good advertising, or product becomes popular.

Name a factor that can shift demand left (decrease).

Lower income, product goes out of fashion, or better substitutes appear.

What is supply?

How much a company is willing to sell at different prices.

Name a factor that can increase supply.

Lower production costs or better technology.

Name a factor that can decrease supply.

Higher production costs or shortage of materials.

What is equilibrium price?

The price where supply equals demand.

What happens if price is above equilibrium?

Too much supply, so price falls.

What happens if price is below equilibrium?

Too much demand, so price rises.

What is price elasticity of demand (PED)?

How much quantity demanded changes when price changes.

When is demand elastic?

Quantity changes a lot when price changes (PED > 1).

When is demand inelastic?

Quantity changes little when price changes (PED < 1).

What is a perfectly inelastic demand?

Quantity does not change at all, no matter the price (vertical line).

What is a perfectly elastic demand?

Quantity changes infinitely at a set price (horizontal line).

What is income elasticity of demand?

How much demand changes when income changes.

Give an example of a good with income elasticity > 1.

Luxury goods (demand rises more than income rises).

Give an example of a good with income elasticity 0–1.

Necessities (demand rises less than income rises).

Give an example of a good with income elasticity < 0.

Inferior goods (demand falls as income rises).