chp 15 instructor manual

# chp 15 instructor manual - Chapter 15 PRICING PRACTICES...

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Chapter 15 PRICING PRACTICES QUESTIONS AND ANSWERS Q15.1 Express the markup on cost formula in terms of the markup on price, and use this relation to explain why a 100% markup implies a 50% markup on price. Q15.1 ANSWER The markup on cost, or cost plus, formula gives profit margin expressed as a percentage of cost: Markup on Cost = Cost Marginal Cost Marginal - Price By way of contrast, the markup on price formula gives profit margin expressed as a percentage of price: Markup on Price = Price Cost Marginal - Price Each markup formula provides a useful, but different, perspective on the relative magnitude of the difference between price and cost, or the profit margin. Through simple algebraic substitution and manipulation, each markup formula can be expressed in terms of the other: Markup on Cost = Price on Markup - 1 Price on Markup Markup on Price = Cost on Markup + 1 Cost on Markup A product with a 100% markup on cost has a 50% markup on price, a 50% markup on cost implies a 33% markup on price, and so on. When comparing the markup earned on various items, and in determining the optimal markup, it is crucial to identify the exact specification of the markup formula used. Q15.2 Explain why successful firms that employ markup pricing use fully allocated costs under normal conditions, but typically offer price discounts or accept lower margins during off-peak periods when excess capacity is available.

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208 Chapter 15 Q15.2 ANSWER Fully allocated costs can be appropriate when a firm is operating at full capacity. During peak periods, when facilities are fully utilized, expansion is required to increase production. Under such conditions, an increase in production requires an increase in all plant, equipment, labor, materials, and other expenditures. However, if a firm has excess capacity, as during off-peak periods, only those costs that actually rise with production--the incremental costs per unit--should form a basis for setting prices. Successful firms that employ markup pricing use fully allocated costs under normal conditions but offer price discounts or accept lower margins during off-peak periods when excess capacity is available. In some instances, output produced during off-peak periods is much cheaper than output produced during peak periods. When fixed costs represent a substantial share of total production costs, discounts of 30 percent to 50 percent for output produced during off-peak periods can often be justified on the basis of lower costs. “Early Bird” or afternoon matinee discounts at movie theaters provide an interesting example. Except for cleaning expenses, which vary according to the number of customers, most movie theater expenses are fixed. As a result, the revenue generated by adding customers during off-peak periods can significantly increase the theater's profit contribution. When off-peak customers buy regularly priced candy, popcorn, and soda, even lower afternoon ticket prices can be justified. Conversely, on Friday and Saturday nights when movie theaters operate at peak
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## This note was uploaded on 03/08/2011 for the course ECONABA 635 taught by Professor Leiter during the Summer '10 term at Andrew Jackson.

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chp 15 instructor manual - Chapter 15 PRICING PRACTICES...

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