University:
Stanford University
Course:
ECON 202 | Microeconomics I
Academic year:

2023
Views:

230

Pages:

2
Author:

T. Elton

Inflation If increases in costs cannot be offset by greater productivity (which they rarely can), increased prices will be the only way to maintain existing profit margins. In the case of long-term contracts, if cost inflation is anticipated, the tendering company will be torn between: (a) a natural desire to win the contract; (b) an equally natural reluctance to enter into any fixed price contract (c) which might lead at best to reduced margins, at worst to a loss; the knowledge that building anticipatory increases into the quoted price could lead to the loss of the contract to a more modestly priced competitor who might face a different cost profile. The two usual approaches to this problem are: 1. To write an 'escalation clause' into the contract, pointing out that competitors who do not do likewise will either cut corners (which could have quality and perhaps safety connotations), or will seek to recover their losses through overpricing of any subsequent modifications or additions to the original contract specification. 2. To adopt one of the two policies criticized under 1 above, viz. to quote a noninflationary tender price in the expectation of obtaining compensatory increases in revenues by means of highly priced amendments. In more normal trading situations (i.e. those not involving fixed-priced contracts), our earlier discussions of markets and demand curves would indicate the difficulties faced by many firms in obtaining a suitable price increase, and therefore alternatives must be sought when inflation is experi enced or expected. These might include the following strategies: a. Marketing. Producing a 'new' or differentiated product, with a price structure that is designed to cover both the inflationary costs and the marginal costs of differentiation. Alternatively, or additionally, those products which show the highest contributions under the revised cost structures could be consciously promoted in an attempt to shift the sales mix in a favourable and compensatory manner. b. Distribution. Restructuring the system of quantity discounts and minimum order quantities so that the break point' occurs at a much lower level. c. Physical adjustment. Reducing the quantity of the product in an imperceptible and cost-effective way. Well-known examples include putting fewer peas in a tin, and less chocolate in a bar. Of course, if a price increase is acceptable to the market, then it might be possible to build into it a certain 'cushion' against future cost increases. This also has the merit of avoiding loss of customer goodwill (and business) by having more frequent price revisions.