Target Costing and Cost Analysis for Pricing Decisions Chapter 15 Target Costing and Cost Analysis for Pricing Decisions

Major Influences on Pricing Decisions Political, legal, and image issues Competitors Costs Customer demand Pricing Decisions Learning Objective 1

How Are Prices Set? Market Forces Costs Prices are determined by the market, subject to costs that must be covered in the long run. Costs Market Forces Learning Objective 2 Prices are based on costs, subject to reactions of customers and competitors.

Economic Profit-Maximizing Pricing Firms usually have flexibility in setting prices. The quantity sold usually declines as the price is increased.

Quantity sold per month Total Revenue Curve Dollars Total revenue Curve is increasing throughout its range, but at a declining rate. Quantity sold per month

Demand Schedule and Marginal Revenue Curve Dollars per unit Sales price must decrease to sell higher quantity. Demand Revenue per unit decreases as quantity increases. Marginal revenue Quantity sold per month

Total Cost Curve Dollars Total cost increases at an increasing rate. Total cost increases at a declining rate. Quantity made per month

Marginal Cost Curve Dollars per unit Marginal cost Quantity where marginal cost begins to increase. Quantity made per month

Determining the Profit-Maximizing Price and Quantity Dollars per unit p* Demand Marginal cost Marginal revenue Quantity made and sold per month q*

Determining the Profit-Maximizing Price and Quantity Dollars per unit Profit is maximized where marginal cost equals marginal revenue, resulting in price p* and quantity q*. p* Demand Marginal cost Marginal revenue Quantity made and sold per month q*

Determining the Profit-Maximizing Price and Quantity Total cost Dollars Total revenue Total profit at the profit-maximizing quantity and price, q* and p*. Quantity made and sold per month q*

The impact of price changes on sales volume Price Elasticity The impact of price changes on sales volume Demand is elastic if a price increase has a large negative impact on sales volume. Demand is inelastic if a price increase has little or no impact on sales volume.

Cross Elasticity The extent to which a change in a product’s price affects the demand for other substitute products.

Limitations of the Profit-Maximizing Model A firm’s demand and marginal revenue curves are difficult to discern with precision. The marginal revenue, marginal cost paradigm is not valid for all forms of markets. Marginal cost is difficult to measure.

Role of Accounting Product Costs in Pricing Optimal Decisions Suboptimal Decisions Economic pricing model Cost-based pricing Sophisticated decision model and information requirements Simplified decision model and information requirements Marginal-cost and marginal-revenue data Accounting product- cost data Learning Objectives 3-11 can be found in the Text Book More costly Less costly The best approach, in terms of costs and benefits, typically lies between the extremes.