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The micro economic principle of profit maximization suggests pricing by the marginal analysis.
That is by equating MR to MC. However the pricing methods followed by the firms in practice
around the world rarely follow this procedure. This is for two reasons; uncertainty with regard to
demand and cost function and the deviation from the objective of short run profit maximization.
It was seen that there is no unique theory of firm behavior. While profit certainly on important
variable for which every firm cares. Maximization of short run profit is not a popular objective
of a firm today. At the most firms seek maximum profit in the long run. If so the problem is
dynamic and its solution requires accurate knowledge of demand and cost conditions over time.
Firms translate pricing objectives into pricing decisions in two major steps. First, someone must
accept responsibility for making pricing decisions and administering the resulting pricing
structure. Second, someone must set the overall pricing structure. a firm sets not a single price,
but rather a pricing structure that covers different items in its line. This pricing structure
changes over time as products move through their life cycles. The company adjusts product
prices to reflect changes in costs and demand and to account for variation in buyers and

Method adopted by a firm to set its selling price. It usually depends on the firm's average costs,
and on the customer's perceived value of the product in comparison to his or her perceived value
of the competing products. Different pricing methods place varying degree of emphasis
on selection, estimation,and evaluation of costs, comparative analysis,andmarket situation.

Profit maximization: the objective of any business enterprise is to make profits.

traditional economic theory believes firms try to maximize profits.
Sales maximization: the managers of the business units may try to maximize sales and
obtain market domination by penetration their sales. In such cases firms determine prices
at such levels where they try to maximize sales rather than profits.
To attain a fixed rate of return on investment: some business firms try to determine the
prices at such levels where they try to get a certain amount of fixed returns on their
investments at least in the long run perspectives.
Maintain product distinctiveness and brand image: firms may try to fix prices in such a
way where they try to maintain their product distinctiveness. Some of them may fix high
prices to prove the quality of their product and establish that their products are different
from those of the other products in the markets.
To prevent governmental interference: some producers fix reasonable prices for their
products in order to avoid unwanted interference by govt agencies.

To prevent the entry of potential competitors: to prevent the entry of competitors even
the Monopoly firms try to charge low prices.
To avoid price war: price war among oligopoly is always destructive to all the firms. To
avoid the price war oligopoly firms try to follow the fixed prices.
To accept social responsibility: modern business enterprises feel their business is not just
to make profits but to serve the society in some or the other. Such firms charge a low price
than profit maximizing one .
To maximize long run profits than short run profits: firms that are interest in long run
profits than short run profits may charge low initial prices that will prevent competition
and entry of new firms into that product line.

The important pricing methods followed in practice are shown in the chart.


There are three versions of the cost based pricing. Full cost or break even pricing, cost plus
pricing and the marginal cost pricing. Under the first version, price just equals the average (total)
cost. In the second version, some mark-up is added to the average cost in arriving at the price. In
the last version, price is set equal to the marginal cost. While all these methods appear to be easy
and straight forward, they are in fact associated with a number of difficulties. Even through
difficulties are there, the cost- oriented pricing is quite popular today.


Some commodities are priced according to the competition in their markets. Thus we have the
going rate method of price and the sealed bid pricing technique. Under the former a firm prices its
new product according to the prevailing prices of comparable products in the market. If the
product is new in the country, then its import cost inclusive of the costs of certificates, insurance,
Eg: when maruti car was first manufactured in India, it must have taken into account the prices of
existing cars, price of petrol, price of car accessories, etc.


The seller knows rather well that the demand for its product is a decreasing function of the price
its sets for product. Thus if seller wishes to sell more he must reduce the price of his product, and
if he wants a good price for his product, he could sell only a limited quantity of his good. Demand
oriented pricing rules imply establishment of prices in accordance with consumer preference and
perceptions and the intensity of demand.
Two general types demand oriented pricing rules can be identified.
1. Perceived value pricing and
2. Differential pricing
Perceived value pricing considers the buyers perception of the value of the product ad the basis
of pricing. Here the pricing rule is that the firm must develop procedures for measuring the
relative value of the product as perceived by consumers.
Differential pricing is nothing but price discrimination. In involves selling a product or service
for different prices in different market segments. Price differentiation depends on geographical
location of the consumers, type of consumer, purchasing quantity, season, time of the service etc.
E.g. Telephone charges, APSRTC charges.
A firm which products a new product, if it is also new to industry, can earn very good profits it if
handles marketing carefully, because of the uniqueness of the product. The price fixed for the new
product must keep the competitors away. Earn good profits for the firm over the life of the product
and must help to get the product accepted. The company can select either skimming pricing or
penetration pricing.


Market-skimming pricing or creaming:

In most skimming, goods are sold at higher prices so that fewer sales are needed to break even.
Selling a product at a high price, sacrificing high sales to gain a high profit is therefore
"skimming" the market. This strategy is employed only for a limited duration to recover most of
the investment made to build the product.
Penetration pricing
Penetration pricing includes setting the price low with the goals of attracting customers and
gaining market share. The price will be raised later once this market share is gained.

The strategy for setting a products price often has to be changed when the product is part of a
product mix. In this case, the firm looks for a set of prices that maximizes the profits on the total
product mix. This pricing is difficult because the various products have related demand and
costs and face different degrees of competition.

Optional-product pricing: Many firms use this strategy by offering to sell optional or
accessory products along with their main product. These firms have to decide which
items to include in the base price and which to offer as options.
Captive-product pricing: Firms that make products that must be used along with a main
product are using this pricing strategy. Producers of the main products often price them
low and set high markups of the supplies. For a competitor who does not sell these
supplies, he will have to price his product higher in order to make the same overall profit.
By-product pricing: In producing certain products, there are by-products. If these by
products have no value and if getting rid of them is costly, this will affect the pricing of
the main product. Using by-product pricing, the manufacturer will seek a market for these
by-products and should accept any price that covers more than the cost of storing and
delivering them. This practice allows the marketer to reduce the main products price to
make it more competitive.
Product-bundle pricing: Using this strategy, marketers combine several of their
products and offer the bundle at a reduced price. Price bundling can promote the sales of
products consumers might not buy otherwise, but the combined price must be low enough
to get them to buy the bundle.


Discount and allowance pricing: Most firms adjust their basic price to reward customers for
certain responses, such as cash payment, early payment of bills, volume purchases and offseason buying. Some of those adjustments are described below:

Cash discounts A cash discount is a price reduction to buyers who pay their bills
Quantity discounts A quantity discount is a price reduction to buyers who buy large
Functional discounts A functional discount (also called trade discount) is offered by
the seller to trade channel members who perform certain functions, such as selling,
storing and record keeping.
Seasonal discounts A seasonal discount is a price reduction to buyers who buy out of
season. It allows the seller to keep productions steady during the entire year.
Allowances They are another type of reductions from the list price. Trade-in
allowances are price reductions given for turning in an old item when buying a new

Discriminatory pricing: Firms will often adjust their basic prices to allow for differences in
customers, products and locations. In discriminatory pricing, the firm sells a product or service
at two or more prices, even though the difference in prices is not based on differences in
costs. Discriminatory pricing takes many forms as indicated below:

Customer-segment pricing Different customers pay different prices for the same
product or service.
Product-form pricing - Different versions of the product are priced differently, but not
according to differences in their costs.
Location pricing Different locations are priced differently, even though the cost of
offering in each location is the same.
Time pricing - Prices vary by the season, month, day and even hour.

Psychological pricing: It applies the belief that certain prices or price ranges make products
more appealing to buyers than others. In using psychological pricing, sellers consider the
psychology of prices and not simply the economics.
Odd pricing In odd pricing, marketers set prices at odd numbers just under round
numbers. An odd ending conveys the notion of a discount or bargain to the customer.
Value pricing: During slow-growth times, many firms adjust their prices to bring them into line
with economic conditions and with the resulting fundamental shift in consumer attitudes toward
quality and value. Value pricing is offering just the right combination of quality and good
service at a fair price.
Promotional pricing: In promotional pricing, a lower-than-normal price is used as a
temporary ingredient in a firms selling strategy. Some promotional pricing arrangements form
part of recurrent marketing initiatives. Some may be to introduce a promotional model or
brand with special pricing to begin competing in a new market. Promotional pricing takes
several forms and some of them are described below.
Loss-leader pricing It happens when retailers drop price on well-known brands to stimulate
store traffic in the hope that customers will buy other items also, at normal mark-ups.
Special-event pricing Sellers use special-event pricing in certain seasons to draw in more
customers. The seasonal need of the customers is capitalized on by the sellers using this pricing
Cash rebates Manufacturers will sometimes offer cash rebates to consumers who buy the
product from dealers within a specified time.

Low-interest financing, longer payment times, longer warranties all these represent the
promotional incentives offered by the sellers to the buyers. Since they provide some
flexibility and also bring down the perceived risks (in case of longer warranties), buyers
are motivated to make the buying decision.

Psychological discounting The seller may simply offer discounts from normal prices to
increase sales and reduce inventories. For the buyer, the motivation to buy below normal prices
may be compelling.
Geographical pricing: Geographical considerations strongly influence prices when costs must
cover shipping heavy, bulky, low-unit-cost materials. Buyers and sellers can distribute
transportation expenses in several ways:
(1) The buyer pays all transportation charges;
(2) The seller pays all transportation charges; or
(3) The buyer and the seller share the charges. This choice has particularly important effects
for a firm seeking to expand its geographic coverage to distant markets. The sellers pricing
can implement several alternatives for handling transportation costs.
International pricing: A wide variety of internal and external conditions can affect a
marketers global pricing strategies. Internal influences include the firms goals and
marketing strategies, the costs of developing, producing and marketing its products, the nature
of the products and the firms competitive strengths. External influences include general
conditions in international markets, especially those in the firms target markets, regulatory
limitations, trade restrictions, competitors actions etc.
Cost-plus pricing: Cost-plus pricing is the simplest pricing method. The firm calculates the cost
of producing the product and adds on a percentage (profit) to that price to give the selling price.
Transfer pricing: The price that is assumed to have been charged by one part of a company for
products and services it provides to another part of the same company, in order to calculate each
division's profit and loss separately.
Peak-load pricing: it is a pricing technique applied to public goods Instead of different demands
for the same public good, we consider the demands for a public good in different periods of the
day, month or year, then finding the optimal capacity (quantity supplied) and, after wards, the
optimal peak-load prices.

In real business world, firms practices numerous pricing strategies followed by firms in specific
situations. A prudent producer follows a good mix of the various pricing methods rather than

adapting any once of them. This is because no method is perfect and every method has certain
good features further a firm might adopt one method at one time and another method at some other