Policy Determinants

Policy determinants Introduction We conclude this section by examining pricing in its broader business environment. More has been written about price than any other variable in the marketing mix. Although the emergence of marketing as a separate discipline is a twentieth-century development, pricing has been a prominent feature in the literature from the very beginning. Economists have taken a formal academic interest in the subject for around 200 years, and accountants have been concerned with the practical impact for more than ten times that period. The overriding aim of business organizations is profitability, and more particularly profit maximization. This is not to say that other objectives might not also be actively pursued in support of this, as we saw in chapter 1, but profitability must be the principal focus. Businesses make profits by selling goods and services at a price higher than their cost. In most markets, the amount that they are able to sell will be largely determined by the price charged for the goods and services. There is a direct and tangible link between prices and profits, and the importance of the pricing decision lies in its pivotal contribution to the fundamental policy of profit maximization. Markets Markets can be classified according to the number of suppliers present, and according to the homogeneous or differentiated nature of the product sold. The ability of any individual supplier to determine the selling price will be a function of the particular market. The main categories can be described as follows: 1. Many suppliers a) Homogeneous product PERFECT COMPETITION b) Differentiated product MONOPOLISTIC COMPETITION 2. Few suppliers a) (а) Sole supplier MONOPOLY b) (b) Few suppliers OLIGOPOLY The different nature of these individual market categories, and the relative manoeuvrability of suppliers in respect of selling prices in each of them are set out below. In each case, it should be borne in mind that economic theory states that profits will be maximized at the point at which marginal cost = marginal revenue. However, the size of the profit will depend on the relation of price and average cost at this particular point, and therein lies the significance of the different market categories. Note that average cost includes a return to the suppliers of capital. Perfect competition. Where there are a large number of suppliers of a homogeneous product, no single supplier can influence the market price, and thus there is no pricing decision to be made. Since all the supplier's output could be sold at the ruling market price, the only effect of a decrease in price would be a reduced profit. Similarly, any increase in selling price by any one supplier would result in no sales at all accruing to that supplier, as buyers could purchase the same product at a lower market price from any number of other suppliers remember that we are dealing with a purely homogeneous product and not one differentiated by marketing strategies). Suppliers must accept the market price, which by definition is their marginal revenue. Profits will be maximized by producing and selling up to the point where the marginal costs of production and sales equal the marginal revenue, i.e. the market price. 'Maximized' in the context of perfect competition in equilibrium, however, means that profit will merely be sufficient to provide an acceptable return to the suppliers of capital, as Figures 11.1 and 11.2 show. Conditions of perfect competition are rarely met with in practice. Monopolistic competition. This, and the remaining two categories, could be described as markets in which the individual supplier is faced with a pricing decision. In monopolistic competition, there are a large number of suppliers producing similar but not identical goods and services. Although product differentiation by such means as brand imaging will give an individual supplier a measure of monopolistic power, the fact that the products are similar in nature - and thus close substitutes - implies that the demand for them will be elastic. Despite the 'monopoly' that each supplier enjoys over his product, he will be faced with a downward-sloping demand curve, where changing prices will have a significant effect on the quantity sold. In view of the number of suppliers, there is an underlying assumption of free entry into such markets, such that long-run super-profits are impossible, because of the ability of other suppliers to set up and produce a different brand of the same product under identical cost conditions. This assumption also has the corollary that market forces will limit the manoeuvrability of any individual supplier to set prices which differ markedly from those ruling in the market. Figure Perfect Competition Figure Perfect Competition