BUSINESS STUDIES NOTES

4.3.4 PRICE MIX

NAME: __________________________________ DATE: ___________

THE SECOND P - PRICE

Price is the amount of money that the customers have to pay in exchange for a product or
service. Determining the right price for a product can be a bit tricky. Price can have a great
impact on the consumer demand for the product
Price regulates the demand.
Price is used as an effective competitive weapon.
Price affects Revenue and Profits.
PRICING OBJECTIVES –
• Profitability - prices should increase overall profitability of the firm
• Rate of return – a specified return on capital employed (ROCE)
• Growth – the price should provide a steady profit over a period of years to enable the firm
to survive and grow.
• Competition – should be competitive and attractive to customers
• Market share – price must be set which enables a firm to rise/maintain its market share.
• Utilization of capacity – it should cover fixed costs and enable the firm to fully utilize
capacity, thus spreading unit costs over a larger output.

PRICING METHODS
➢ COMPETITION BASED PRICING
Competitive pricing involves setting prices in line with your competitors’ prices or just below
their prices. It is suitable where there is large number of competitors. If the firm is selling a
differentiated product, they can charge a higher price. Differentiated product is that where
customers see as being different from any other similar products. If they are selling the same
type of product, they can charge the same price and then offer after sale services to attract
more customers.
It involves the use of different prices for the same product when it is sold in different locations
or market segments e.g. wholesalers may receive trade discounts while small buyers in remote
areas may be charged a higher price due to additional distribution costs.
Competitive pricing is common when consumers can easily make a direct comparison
between different products. The rise in internet usage has made it easier for customers to
compare prices between firms; this puts more pressure on firms to be competitive
Benefits

• Sales are likely to be high as the price is at a realistic level and the product is not under-
or over-priced.
• Avoids price competition, which can reduce profits for all businesses in the industry.
• Often used when it is difficult for consumers to tell the difference between the products of
different businesses.
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This is almost essential for firms with little market power – price takers.
• It can be flexible to reflect market and competitive conditions

Limitations
• If the costs of production for a business are higher than those of competitors – perhaps
because the product is of a higher quality – then a competitive price could lead to losses being
made.
• A higher quality product might need to be sold at a price above competitors’ prices to give it
a higher quality image.
• In order to decide what this price should be, detailed research would be needed into what
prices competitors are charging, and this research costs time and money
The price set may not cover all the costs of production.
• The price may have to vary frequently due to changing market and competitive conditions

➢ PENETRATION PRICING
The main objective is to capture a large share of the market as quickly as possible. It depends
on the expected product life. It is mainly used for products with a longer life. Low prices are set
in the initial stages of the product and gradually increased as it gains market share. Consumer
products are often introduced this way. It is suitable where there is stiff competition.
Penetration pricing means the price would be set lower than the competitors’ prices.
This strategy uses a low price to enter the market and gain market share. This makes
sense if there are cost advantages from producing on a large scale. Firms tend to adopt
penetration pricing because they are attempting to use mass marketing and gain a large
market share. If the product gains a large market share, then the price could slowly be
increased during the growth stage of the product life cycle. This would increase the profit
margin on the product

Advantages

• High sales volumes and low prices stop entry of competitors

• High sales volume reduces average costs (economies of scale)
• Increase in brand awareness
• Often used for newly launched products to create an impact with customers.
• High market share

Disadvantages
• Consumer resistance when prices are increased in the future
• May result in brand seen as low quality
• Low profit margins
• Might not be appropriate for a branded product with a reputation for quality

➢ MARKET SKIMMING PRICING

It uses high prices to obtain high profit margins and a quick recovery of development costs.
It is useful for products with a short life cycle and fashion items e.g. computers, videos, toys,
CDs etc. It is ideal for technological goods and where there is less competition. With price
skimming, the product is usually a new invention, or a new development of an old
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 product. Therefore, it can be sold on the market at a high price and people will pay this high
price because of the novelty factor. The product will often have cost a lot in research and
development, and these costs need to be recouped. Sometimes the high price can be
used to help indicate the high quality of the product. This strategy uses a high price to
enter a market. Even though the price is high, some people may still be eager to try a new
product.

Once sales from this group of people have been exhausted, the price can be dropped to
attract a new group of customers. When this group is exhausted, the price can be cut again.
A price skimming strategy is appropriate if the firm can protect its idea or invention
so that competitors cannot enter with a cheaper version in the early stages.
This strategy is often used with new technology; for example, the latest computer or
computer accessory enters the market with a high price, which then falls quite rapidly a year
or so later

Advantages
• High prices give appearance of quality and a must have ‘factor’
• Some customers pay high prices for a new unique product
• High prices cover development and marketing costs
• More profits to the business

Disadvantages
• High prices may discourage buyers
• Early buyers at high prices may be discouraged when price falls & they will not buy again
• Buyers may wait as they know price will fall
• Attract new competitors

➢ COST-PLUS PRICING
The firms will assess the cost of producing each unit of the product and add a certain amount
on top of the calculated cost. It also includes mark-up pricing which involves adding a fixed
mark-up for profit to the unit price of a product. It considers all the relevant costs. But the
problem is that it can lead to higher prices.

Cost-plus pricing involves: • estimating how many units of the product will be produced
calculating the total cost of producing this output • adding a percentage mark-up
for profit.

Benefits
• The method is easy to apply.
• Different profit mark-ups could be used in different markets.
• Each product earns a profit for the business.

Limitations
• Businesses could lose sales if the selling price is higher than competitors’ prices.
• A total profit will only be made if sufficient units of the product are sold.
• There is no incentive to reduce costs – any increase in costs is just passed on to the
customer as a higher price.

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➢ PSYCHOLOGICAL PRICING

Psychological pricing takes account of the psychological effect of a price on customers.

For example, a high price for consultancy work might suggest that the person is an expert; if
the price is too low customers may worry about the consultant’s competency. Other examples
of psychological pricing are: – charging, say, $49.99 rather than $50.
In the customer’s mind, this makes the price ‘$40 something’ rather than ‘$50 something’ and
therefore more attractive. – putting ‘was’ and ‘now’ or ‘sale’ to suggest this is a bargain. For
example, ‘was $20, now $15’ may be more appealing than just stating ‘$15’.It involves setting
a price at just below a whole number e.g. $99,99, making customers feel they are paying much
less than $2.00, so they more likely to buy than if the price were $2.00

➢ DYNAMIC PRICING
It occurs when prices are changed at different times to reflect demand conditions.
Example :Airlines may change prices according to when you book, utility companies may
change rates according to demand for their services during a day, theatres, cinemas and
sports stadium may change the ticket prices depending on when you are looking.
Dynamic pricing is much easier with online ordering, where the business can track in
real time the availability of places or products and measure levels of demand by the number of
searches and enquiries, and then adjust the price accordingly.
For the business, it means it does not have to estimate demand in advance and set what it
hopes is the right price – it can adjust continually, increasing it if demand looks high and
reducing it if demand is low.
This should allow the business to control demand more effectively and ensure, for example,
that its planes, hotels and sports arenas are full.
• The business should be able to maximize revenue (increasing prices if demand is
high to ration the products available rather than turning people away) and make full
use of the capacity available.
• From a customer’s perspective, it means be prepared to discover you paid a very
different price from the person in the seat next to you!
• The dynamic pricing method involves setting constantly changing prices when
selling products to different customers, especially online through e-commerce.
• E-commerce has become a hot spot for dynamic pricing models, due to the way
consumers can be separated by and communicated with over the internet.
• Businesses can vary the price according to demand patterns or knowledge that they
have about a particular consumer and their ability to pay. Airlines often use this
method of pricing.
• On a typical flight it is rare to find any two passengers who have paid the same fare.
• Dynamic pricing can also be used, often when products are sold ‘online’, to reflect rapid
changes in the level of demand.
• If demand increases then the price will be raised, and at times of low
demand the price will be reduced.
For example, at American football games ticket prices often change to reflect the increased
demand for tickets at popular games and when a game is less popular the price is reduced to
encourage sales and fill the stadium seats.

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➢ PRICE DISCRIMINATION
This pricing method is often used in markets where it is possible to charge different groups of
consumers different prices for the same product. An example of price discrimination would be
bus or train companies charging lower prices for the elderly than they do for other adults, for
the same journey.

Businesses can price discriminate profitably if there are different groups of consumers, where
the business is able to avoid resale between the groups and when it does not cost too much to
keep the consumer groups separate.

Other examples of price discrimination include selling cinema or theatre tickets more cheaply to
children or the elderly

This occurs when different prices are charged for the same product. You will sometimes
find that demand conditions for the same product can vary and the price changes as a result.
Price discrimination may occur when firms charge different prices: – at different times
of day; for example, taxi fares may be higher after midnight – to different age groups; for
example, lower fares on the bus for children and pensioners – to different customer groups; for
example, discounts for members.

PRICE ELASTICITY OF DEMAND (PED)

Price Elasticity of Demand or PED refers to the responsiveness of the quantity

demanded for a product due to a change in its price.
It measures the extent to which units demanded respond to a decrease or increase in price.
▪ INELASTIC PED - If the PED is between 0 and 1 (ignore negative sign)
Producers can increase the price to maximise profits. A given increase in price will lead to a
less than proportionate decrease in quantity demanded. The product has very few substitutes
▪ UNITARY PED - If the answer is equal to 1 (ignore negative sign)
Producers should maintain the price.
▪ ELASTIC PED - If the answer is greater than 1 (ignore negative sign)
Producers can reduce the price to maximise sales. A given decrease in price will lead to a
more than proportionate increase in quantity demanded. The product will be having a lot of
substitutes.

INELASTIC GOODS
Inelastic goods don't have a significant change in demand or supply in response to a price
change. In general, these are goods that are considered necessary or without many (or any)
substitutes. Using demand as an example, if the price of a good were to decrease by X
amount, there would be a smaller increase in the amount that people would want to buy. If
the price were to increase by X amount, there would be a smaller decrease in the amount that
people would want to buy.

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 ✓ Life-Saving Medication :If a person requires a life-saving medication (e.g. insulin),
they'll need to buy it regardless of the price. Adjustments to price will have a small
effect on the demand.
✓ Gas :The vast majority of cars use gasoline for fuel, so people will continue to buy it
regardless of the price. Otherwise, they won’t be able to get to work, run errands, etc.
✓ Electricity :Electricity is an essential part of our lives, so changes in the price would
not have much of an effect on the demand for it. People might use it slightly less if the
price increases, but most don’t have the option to stop using it or switch to an
alternative source of power.
✓ Demerit Goods: Goods like cigarettes are inelastic because they are addictive.
Quitting is not always an option so people will continue to pay for them if the price
increases.
✓ Post-Secondary Education: Many careers require a post-secondary degree or
certification that can’t be obtained outside of colleges and universities. Tuition increases
in price have little effect on the demand for post-secondary education. On the other hand,
decreases in tuition costs won’t have a major effect on demand because most people
only pursue one degree.

ELASTIC GOODS
Elastic goods are goods that have a significant change in demand or supply in response to a
change in price. Generally, these are goods that are not considered necessities, or goods for
which there are substitutes readily available.
Using demand as an example, if the price of a good were to decrease by X amount, there
would be a greater increase in the amount that people would want to buy. If the price were to
increase by X amount, there would be a greater decrease in the amount that people would
want to buy.
Examples of Elastic Goods
✓ Soft Drinks :Soft drinks aren't a necessity, so a big increase in price would cause
people to stop buying them or look for other brands. A big decrease in price, however,
would be sure to attract more buyers.
✓ Cereal :Like soft drinks, cereal isn't a necessity and there are plenty of different
choices. A change in prices would have a big impact on the demand.
✓ Clothing :Similar to the above two examples, any particular item of clothing is not a
necessity. Since buyers have a massive number of options, demand is largely affected
by price.
✓ Electronics :Most electronics have multiple options at varying price points.
Adjustments to price will greatly influence the demand for an item.
✓ Cars :While many people shop for specific cars, there are many makes and models. If
the price of a car increases, people will consider similar models. On the other hand, if
the price decreases, more people will be interested in buying that car

EXPLAIN HOW PED IS USED IN PRICING DECISION

Price elasticity of demand is a crucial factor in making pricing decisions for goods and services.
It is the measure of the sensitivity of the quantity demanded of a product to change in its price.
The following are the ways price elasticity of demand is used in pricing decisions:

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1. Setting the correct price point: Price elasticity of demand assists in determining the
optimal price point at which the product will sell best. The higher the elasticity, the lower the
price must be to stimulate demand.

2. Maximizing revenue: Businesses use price elasticity of demand to figure out the best
possible price to sell their products, leading to maximum revenue. Knowing the price elasticity
of demand can help businesses to choose the price that maximizes profit - the sweet spot where
revenue is the highest.

3. Responding to changes in the market: Understanding the price elasticity of demand can
help businesses respond to changes in the market. For example, if the demand for a product is
very elastic, the business owner can adjust the price quickly when competitors launch a new
product or discount their own products.

4. Launching new products: Price elasticity can assist businesses in pricing their new
products. If the product is inelastic, the business can charge a premium price, whereas if the
product is elastic, lower prices will maximize sales and profits.

5. Managing inventory: It is important to take price elasticity of demand into account when
making inventory management decisions. Understanding the product’s elasticity can help
prevent stock overages or shortages, as businesses can adjust the price to stimulate or reduce
demand.

In conclusion, price elasticity of demand is crucial in making pricing decisions as it helps

businesses understand the market demand for their products and services, set the right price
point, maximize revenue, respond to changes, develop new products, manage inventory, and
discount products or services.

Identify, Analyse, and Evaluate the factors which determine the price of a product

➢ Cost of production

Although in the short term a firm may sell an item at a loss to get it established in a market, in
the long term a product will nearly always have to generate a profit. This means the price has
to be greater than the cost per unit. Some organizations (such as museums and hospitals)
are non-profit making and so do not necessarily have to cover their costs. However, most firms
in the private sector have to make a long-term profit to survive. The price therefore cannot fall
below the unit cost for too long.
➢ Competition

Competitors The price that a business sets for its product must take account of competitors’
prices. If competitors are offering a similar product or service and it is easy to switch from one
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to the other, firms are likely to set similar prices to each other. This is why businesses
will often stress the particular benefits of what they are offering, so they can justify a higher
price. If customers believe a product provides better value for money, they may still buy it even
if it is more expensive.

➢ Business objectives.

The objectives of the business the price charged by a firm will be influenced by its
objectives. If a firm has a particular profit target, this will influence the price that is set per
unit. If, however, it is aiming for a high market share (at least in the short term) it may be
willing to sell at a lower price if this will help to boost sales.

➢ Price elasticity of demand

The sensitivity of demand to price changes the sensitivity of demand to price is

measured by the price elasticity of demand. Demand for some products is very sensitive
to the price, as people shop around for the best deal. Other items may not be so sensitive; for
example, if it is an exclusive item.

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