AC114: Chapter 4 - Pricing Calculations

Cost-plus pricing + Formula

Setting price by adding a mark-up to cost.

Formula: selling price = cost × (1 + mark-up %).

Advantages of full cost-plus pricing (QECJ)

• Quick and simple.

• Easy to delegate to junior staff.

• Covers all costs at normal output.

• Justifies price rises when costs increase.

Disadvantages of full cost-plus pricing (IO)

• Ignores demand.

• Overheads are often allocated arbitrarily.

Main criticism of cost-plus pricing

Ignores demand and doesn’t find the profit-maximising price.

Marginal cost-plus pricing

Pricing by adding a mark-up to variable (marginal) cost only.

Mark-up vs margin

• Mark-up = profit as % of cost

• Margin = profit as % of selling price

Margin is based on what?

Selling price

Selling price using margin

Selling price = Cost × 100/100 - margin %

Transfer price

Price charged when one division sells to another within the same company.

Transfer pricing methods (MCTD)

• Market price: Set by market not by firm

• Cost-plus: Cost + mark-up = selling price.

• Two-part tariff: Fixed access fee + charge per unit used.

• Dual pricing: Buying and selling divisions record different prices

Spare capacity transfer price

Variable cost only — no lost external sales (opportunity cost).

Full capacity transfer price

Market price (minus any internal cost savings e.g delivery charge to firm) — reflects the opportunity cost of lost external sales.

Goal congruence for transfer pricing

Divisions make decisions that maximise total company profit.

What is a demand curve

Shows price vs quantity demanded.

What factors can shift the demand curve? (AQITSC)

• Advertising

• Quality

• Income

• Tastes

• Substitutes

• Complements

What factors influence supply? (CTT+SNS)

• Costs

• Technology

• Taxes/subsidies

• Number of firms

• Substitutes

What is the equilibrium price?

Where demand = supply. Surplus above it, shortage below it.

Demand shift effect on equilibrium

Right shift → price up
Left shift → price down

PED + formula

Responsiveness of demand to price.
Formula: % change in demand ÷ % change in price

How do you interpret PED values?

PED < 1 → inelastic (demand not very responsive to price).

PED > 1 → elastic (demand very responsive).

PED = 0 → perfectly inelastic.

PED = ∞ → perfectly elastic.

Giffen vs Veblen goods

Both have demand rising when price rises.

Giffen = necessity for low income.

Veblen = luxury/status goods.

What is income elasticity of demand?

Measures demand response to income changes.

1 luxury, 0–1 necessity, <0 inferior good.