Pricing Decisions
What this domain tests
Pricing is where cost information meets market strategy. The exam tests cost-plus mechanics, marginal-cost pricing for short-term decisions, target costing, pricing strategies across the product life cycle, and the influence of elasticity and competition.
Core rules
- Profit is maximised where marginal revenue equals marginal cost; the optimal price depends on elasticity, not on cost alone.
- Cost-plus pricing sets price as cost plus a mark-up. Full-cost plus gives a target return but ignores demand and can misprice; marginal-cost plus covers incremental cost and suits short-term spare-capacity work.
- Target costing works backwards: target cost = competitive market price − required profit. The gap is closed through value engineering, design changes and supplier negotiation.
- Price skimming charges high initially to recover development costs from early adopters; penetration pricing sets low to build share and experience effects.
- In competitive bidding the relevant cost is incremental cost plus opportunity cost, not full absorption cost.
- Price discrimination is viable when markets can be separated and resale prevented.
Worked example
A new product can sell at Rs. 4,000. The company requires a 20% margin on selling price. Target cost = 4,000 × 0.8 = Rs. 3,200. The current design costs Rs. 3,600, so the design team must remove Rs. 400 per unit - say Rs. 150 from component rationalisation, Rs. 120 from two assembly hours saved at Rs. 60 per hour, and Rs. 130 from reduced warranty claims. If they cannot, the product fails the target-cost test and should not proceed as designed.
Traps
Confusing mark-up on cost with margin on price (a 25% mark-up equals a 20% margin); using full cost for a special order when capacity is spare; ignoring learning and experience effects in penetration pricing; treating target costing as cost-plus in reverse without the value-engineering loop.