Pricing Theory: Optimizing Profit through Market Analysis and Costing

This essay explores the application of pricing theories under different market structures, including perfect competition, monopolistic competition, and oligopoly, to inform managerial decisions. It emphasizes the significance of market conditions and costing in determining pricing strategies. The analysis incorporates demand elasticity and marginal costing to optimize resource allocation and enhance profitability. Various pricing strategies, such as market penetration, economy pricing, price skimming, premium pricing, bundle pricing, and psychological pricing, are examined for their effectiveness in maximizing returns. The microeconomic theory, particularly the concepts of supply and demand equilibrium, is discussed as a crucial framework for setting optimal prices and mitigating business risks. The essay concludes by highlighting how businesses can leverage these concepts to achieve a balance between supply and demand, ultimately optimizing profit decisions.

Running head: PRICING THEORY: THE ROLE OF MARKET CONDITIONS AND
COSTING
1
Pricing theory: the role of market conditions and costing
Name of Student
Institutional Affiliation
Name of Professor
Date

PRICING THEORY: THE ROLE OF MARKET CONDITIONS AND COSTING
2
TABLE OF CONTENTS
Pricing theory: The role of market conditions and costing.......................................................2
1. Introduction................................................................................................................................2
2. The pricing theories and techniques under different market structures.............................3
2.1. Perfect competition.............................................................................................................3
2.1.1. Determinants for the price under perfect competition.............................................3
2.1.2. The Market of a perishable commodity.....................................................................3
2.1.3. The price for perishable and non-perishable.............................................................4
2.2. Monopolistic competition...................................................................................................4
2.3. Oligopoly..............................................................................................................................4
3. Application of analysis of elasticity (demand) and costing (marginal cost) in decision-
making............................................................................................................................................4
3.1. Elasticity (demand) analysis...............................................................................................4
3.2. Marginal (costing) analysis................................................................................................5
4. Pricing concepts and techniques to optimise profit decisions................................................5
4.1. The microeconomic theory.................................................................................................5
4.2. The pricing strategies..........................................................................................................7
4.2.1. Pricing for a market penetration................................................................................7
4.2.2. Economy pricing...........................................................................................................7
4.2.3. Price Skimming.............................................................................................................7
4.2.4. Pricing at a premium...................................................................................................8
4.2.5. Buddle pricing...............................................................................................................8
4.2.6. Psychology pricing........................................................................................................8
References.......................................................................................................................................8

PRICING THEORY: THE ROLE OF MARKET CONDITIONS AND COSTING
3
Pricing theory: The role of market conditions and costing
1. Introduction
The determination of pricing is a critical aspect of business economics. However, the executive
managers are mandated to come up with financial decisions basing on the knowledge they have
and their judgment. This calls upon these managers to familiarise with the rational and
assumptions behind the pricing decisions which helps to analyse the customer behaviour and the
market needs, and trends. This assignment will therefore, focus on the application of the pricing
theories under the different market structure to make decisions.
2. The pricing theories and techniques under different market structures
The market structure is the number of business organisations in the market that supply or
manufacture similar products or provide identical services. The market structure is known to
influence the supply of different commodities and the behaviour of business firms. When the
competition is stiff, each organisation aims to dominate over the other and the objects to create
barriers for entries of similar companies intending to join the market. However, price fixations is
a vital managerial function that determines the sales to be made and the outcomes regarding of
the market shares. When the firm sets up the price for its products and services too high, the
consumer might not be able to afford whereas when the price is set too low, the firm may not
achieve the set targets concerning the profits and annual returns. Concisely, these prices are
influenced by different market structure conditions including the perfect competition, oligopoly,
and the monopoly market structures.
2.1. Perfect competition
In this structure, the numerous buyers and sellers are well informed while the commodity pricing
is beyond the control of individual firms with the absence of the monopoly elements. This
implies that the demand price elasticity is finite for every firm. The pricing decisions under
perfect competition conditions are highlighted below.
2.1.1. Determinants for the price under perfect competition
The market price for perfect competition is determined by the balance between the supply and
demand in a short run or a market period. The market period is claimed to be a short time where

PRICING THEORY: THE ROLE OF MARKET CONDITIONS AND COSTING
4
the maximum supply of goods is limited by the existing stock thus the market cannot take in
more produce in spite of an increase in demand therefore, making the firms to sell all the current
commodities at their premises.
2.1.2. The Market of a perishable commodity
For the case of perishable products, the supply is limited to the quantity available for that market
period. Since the product cannot be stored until the next period, it must be sold out irrespective
of the pricing decision made under this condition.
2.1.3. The price for perishable and non-perishable
For the non-perishable goods, some can be stored for the next market period thus there will be
two critical pricing levels in this condition. If the prices are very high, the seller will be ready to
release the entire stock to the market whereas if the prices are set low, the seller might stock the
product to wait for the next market period with higher prices.
2.2. Monopolistic competition
A monopoly exists when a single firm is the sole producer of a certain product or service with no
close competitors. Under this market condition, the monopolist is the price maker where they set
their prices without the fear of rival firms entering into the market. (Iyer and Church, 2018)
states that under this market structure, the market power is controlled by the supplier firm that
liberates prices according to their target, which can result in exploitation of the buyers and
consumers.
2.3. Oligopoly
This is a condition where a few businesses are competing for a particular product in the market.
This takes two forms on the pricing decisions where the firms were small, each controls a certain
portion of the market share of the total supply. However, a slight change in pricing by one firm is
acted upon by other firms in efforts to stay above that firm in the market. The entry for new
competitors is difficult as it is neither free nor barred but determined by the pricing to be put in
place by the firm.

PRICING THEORY: THE ROLE OF MARKET CONDITIONS AND COSTING
5
3. Application of analysis of elasticity (demand) and costing (marginal cost) in decision-
making
3.1. Elasticity (demand) analysis
According to (Gostkowski, 2018, pp.68-78), the elasticity of demand is the degree of sensitivity
in the demanded quantity of a product to the change in factors related to that product. It is varied
with the factors causing the change in demand of the services and the commodities. The
managers apply this in making pricing decisions that would lead to highest sales and the profits.
Additionally, in a monopolistic market where the specific companies control the prices, the
elasticity of demand analysis is useful in fixing the prices to ensure they are not very high to
make the make the demand low. This ensures that the business organisation stays on the market
with a sustained supply and demand equilibrium. However, if the business handles the inelastic
products, it can earn profits by setting the prices high while when dealing with the elastic
products the supplier must keep the prices low to attract the consumers. The elasticity of demand
analysis determines these factors.
3.2. Marginal (costing) analysis
This is technique is used by the managers in an optimal allocation of the resources. Marginal
analysis is the examination of the additional benefits resulting from an activity in comparison to
the additional costs invested into the same activity. The tool makes use of the geometric relations
between the marginal and the actual totals thus providing a fruitful basis of resource allocation in
managerial levels. To make a decision using this technique, it is important to determine the
number of resources you are willing to allocate for the intended activity. This is known as the
marginal benefits, which are the satisfaction gained because of an additional unit. The intensity
of the decisions made is based on the degree of the marginal net profit, which is the difference
between the marginal costs, and the marginal benefits of an activity or an action as summarised
below.
Total benefit=Net Benefit −Total Costs
4. Pricing concepts and techniques to optimise profit decisions
Optimisation in economics refers to the efforts to find an alternative that is cost effective and has
the highest achievable performance within the given constraints whereby the desired factors are

PRICING THEORY: THE ROLE OF MARKET CONDITIONS AND COSTING
6
maximised while the undesired are minimised. In order to optimize the profit decisions, the
factors to be considered are the cost of operations, supply and demand concepts in the
microeconomic theory.
4.1. The microeconomic theory
This is the principle used by the managers to make pricing decisions using the concepts of
demand and supply to evaluate the most suitable prices for the goods and services. The
microeconomic theory aims at attaining an equilibrium in the supplied goods meets the market
demand among the consumers. To achieve the balance, the objective is to locate the points of
prices that allow the supplied products to be reasonably covered by the potential consumers. The
theory further aims to address the business risks which are brought about by hiking prices
making the buyers to avoid the products resulting in excess supply. However, setting the rates
too low may result in deficiencies in supply due to higher demand. Therefore, the economists use
this theory in soughing to bring the demand and the supply close to an economic or market
equilibrium as illustrated in the diagram below.
Figure 1: Equilibrium between Supply and Demand

PRICING THEORY: THE ROLE OF MARKET CONDITIONS AND COSTING
7
The theory can be applied by individual small business owners to set their market prices to
achieve the desired profits and maintain a constant supply of the goods and services. For
instance, the theory can be used to determine the trends in the price of a commodity concerning
the quantity of a commodity. This involves studying the interceptions of the markets to evaluate
the general equilibrium of the volumes and prices as presented in the diagram below.
Figure 2: Application of Microeconomic theory in the market price
4.2. The pricing strategies
An effective pricing strategy helps an organisation to determine the price points that will enhance
maximum returns on profits. When optimising the profit decisions, the pricing strategies that can
be applied are discussed below.
4.2.1. Pricing for a market penetration
This strategy is aimed to attract the buyers by lowing the prices on the goods and services
offered. This tends to result to initial loss on the income while the firm penetrates the market.
However, after a sufficient number of buyers is attained due to massive sales, the business
slightly raises the prices to recapture the lost income and gain profits.
4.2.2. Economy pricing
Economy pricing strategy aims to target low-price consumers by minimising the costs
associating with production and marketing to sustain the low-priced goods and services. This
strategy is effective for bigger organisations but can be very dangerous to smaller firms.

PRICING THEORY: THE ROLE OF MARKET CONDITIONS AND COSTING
8
4.2.3. Price Skimming
The skimming strategy involves setting the prices high during the initial stages of a business with
the aim to maximize the sales then the company progressively lowers the prices in case there are
new entries for competitors. The benefit of skimming help the business to make maximum sales
during the initial sales while the lowering prices over time helps to attract the price-conscious
customers. Additionally, the high prices bring the perception of high quality among the
consumers.
4.2.4. Pricing at a premium
In this approach, the firm sets its initial costs higher than their competitors do. The strategy is
useful for small business that deals with unique goods and services.
4.2.5. Buddle pricing
The buddle strategy of pricing is applied in small industries where the products are sold in
multiple, and the price lowered compared to purchasing individual goods. The approach is an
effective way of moving the unsold goods from the business premises and stores.
4.2.6. Psychology pricing
This strategy is used by the marketers to invoke emotional responses rather than logical
responses during the purchase of goods at the sell points. For instance, most businesses put the
price tags by less than one unit (for $300, the price is tagged as $299). This creates an illusion of
enhanced value for the customers as most buyers pay more attention to the first digit than to the
last on a price tag.

PRICING THEORY: THE ROLE OF MARKET CONDITIONS AND COSTING
9
References
Gostkowski, M. (2018). Elasticity of Consumer Demand: Estimation Using a Quadratic Almost
Ideal Demand System. Econometrics, 22(1), 68-78.
Iyer, V., & Church, N. (2018). The Linking Process: Product Life Cycle, Diffusion Process,
Competitive Market structures and Nature of the Market. Red Internacional de
Investigadores en Competitividad, 8(1).