Pricing Policies and Strategies: Objectives, Cost-Plus Pricing, Marginal Pricing and Price Discrimination Questions

Question 1

Define pricing policy.

Accepted Answer

Pricing policy is a set of consistent principles and guidelines used by a firm to set and change prices over time.

Question 2

What is cost-plus pricing?

Accepted Answer

Cost-plus pricing sets price by adding a markup (profit margin) to the full/average cost per unit.

Question 3

What is marginal cost pricing?

Accepted Answer

Marginal cost pricing sets price based primarily on variable/marginal cost, focusing on contribution.

Question 4

What is penetration pricing?

Accepted Answer

Penetration pricing is charging a low initial price to enter a market and quickly gain market share.

Question 5

What is price skimming?

Accepted Answer

Price skimming is charging a high initial price to skim early profits, then lowering price over time.

Question 6

Define contribution.

Accepted Answer

Contribution is the difference between sales price and variable cost (Contribution = Price − Variable Cost).

Question 7

Explain pricing objectives (any five).

Accepted Answer

Pricing objectives (any five):
1) Profit maximisation (short/long run).
2) Sales maximisation (increase volume).
3) Market share/growth (penetration strategy).
4) Survival during recession (cover variable costs).
5) Price stability (avoid frequent price changes).
6) Quality/brand image (premium pricing).

Firms often use multiple objectives depending on market situation.

Question 8

Explain factors affecting pricing decisions (any six).

Accepted Answer

Factors affecting pricing (any six):
1) Cost of production (fixed and variable).
2) Demand conditions and elasticity.
3) Competition and substitute products.
4) Market structure (degree of pricing power).
5) Government policy (taxes, price control).
6) Product life cycle stage.
7) Brand positioning and perceived value.
8) Distribution margins and discounts.

A good price considers cost, demand and competition together.

Question 9

Explain cost-plus pricing with merits and demerits.

Accepted Answer

Cost-plus pricing means price = full cost per unit + markup.
Merits: simple, ensures cost recovery, useful for contracts and stable markets.
Demerits: ignores demand and competition, markup can be arbitrary, may lead to overpricing/underpricing.

Hence it is suitable when demand is stable and competition is limited.

Question 10

Explain marginal cost pricing and its application.

Accepted Answer

Marginal cost pricing sets price based on variable/marginal cost, focusing on contribution to fixed costs.
Applications: accepting special orders, export pricing, using spare capacity, recession pricing where covering variable cost is key.

It helps short-run decisions but should not be used continuously if it fails to recover fixed costs in long run.

Question 11

Differentiate between penetration pricing and skimming pricing.

Accepted Answer

Penetration pricing sets a low initial price to enter market and gain market share; it suits elastic demand, competitive market and economies of scale.

Skimming pricing sets a high initial price to earn high margins from early buyers; it suits innovative products, less competition and brand loyalty.

Thus penetration focuses on volume, while skimming focuses on early profit.

Question 12

Explain price discrimination and state any three conditions.

Accepted Answer

Price discrimination means charging different prices to different customers/markets for the same product, not due to cost differences.
Conditions (any three):
1) Market can be segmented.
2) Different demand elasticities in segments.
3) No resale/arbitrage between segments.
4) Some market power.

It helps increase revenue by charging higher price in less elastic segments.

Question 13

Discuss pricing objectives and factors affecting pricing decisions. Explain how firms balance these in practice.

Accepted Answer

Pricing objectives are the goals a firm tries to achieve through pricing, while factors are conditions that influence the final price. In practice, firms balance objectives with market realities.

Pricing objectives (explain):
1) Profit maximisation: earn maximum profit, either short-run or long-run.
2) Sales maximisation: increase volume and market presence.
3) Market share/growth: use low prices to expand customer base.
4) Survival: during downturns, price may be set to cover variable cost and maintain operations.
5) Price stability: avoid frequent changes to maintain customer confidence.
6) Brand image/quality: premium pricing to maintain prestige and perception of quality.
7) Target ROI: price to earn a target return on investment.

Factors affecting pricing decisions:
- Cost of production (fixed and variable costs)
- Demand conditions and price elasticity
- Competition and availability of substitutes
- Market structure (degree of pricing power)
- Government policies (taxes, price ceilings, regulations)
- Product life cycle stage (intro, growth, maturity)
- Distribution channel margins and discount policy

Balancing in practice:
- A firm starts with cost as a base but adjusts price considering demand and competition.
- If demand is elastic and competition is strong, lower price and efficiency become important.
- For differentiated/premium products, perceived value and brand image matter more, allowing higher price.

Thus pricing is a strategic decision combining objectives, costs, demand and competition.

Question 14

Explain cost-plus pricing and marginal cost pricing in detail. Compare them and state situations where each is suitable.

Accepted Answer

1) Cost-plus (full cost) pricing
- Meaning: price is set by adding a profit margin to full/average cost per unit.
- Price = Full cost per unit + Markup.
Merits: simple, ensures cost recovery, useful for contracts and stable markets.
Demerits: ignores demand and competition; markup may be arbitrary; can cause wrong pricing in competitive markets.
Suitable for: cost-based industries, government contracts, stable demand, limited competition.

2) Marginal cost pricing (contribution pricing)
- Meaning: price is based mainly on variable/marginal cost. The difference between price and variable cost is contribution to fixed cost and profit.
- Contribution = Price − Variable cost.
Merits: focuses on relevant cost for short-run decisions; helps utilise spare capacity; supports special order/export pricing.
Demerits: if used continuously may fail to recover fixed costs; can create price wars and harm brand image.
Suitable for: special orders, recession pricing, disposal of excess inventory, export markets where capacity is underutilised.

Comparison:
- Cost-plus is long-run oriented (cost recovery), while marginal pricing is short-run oriented (capacity and contribution).
- Best practice: use cost-plus for normal pricing and marginal pricing for special situations after checking capacity and long-run effects.

Question 15

Explain penetration and skimming strategies and relate them to elasticity and product life cycle. Add examples.

Accepted Answer

Penetration pricing
- Meaning: setting a low initial price to enter the market quickly and gain market share.
- Suitable when: demand is elastic (buyers are price sensitive), market is competitive, and large-scale production can reduce costs (economies of scale).
- Purpose: build customer base, discourage competitors, increase volume.
Example: low introductory price for a new telecom plan to acquire users.

Skimming pricing
- Meaning: setting a high initial price to ‘skim’ high margins from early buyers, then reducing price later.
- Suitable when: product is new/innovative, competition is limited, and early buyers have low price sensitivity (inelastic demand).
- Purpose: recover R&D cost, earn high profits early, maintain premium image.
Example: new smartphone model launched at high price, later discounted.

Link with elasticity and product life cycle:
- In introduction stage, firms may use skimming (innovation) or penetration (mass adoption) depending on demand and competition.
- Elasticity guides revenue effect: elastic markets respond strongly to price cuts, supporting penetration; less elastic segments support skimming.

Thus strategy choice depends on demand elasticity, competition and life cycle stage.

Pricing Policies and Strategies: Objectives, Cost-Plus Pricing, Marginal Pricing and Price Discrimination

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