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Unformatted text preview: n is the Cost Plus Rule Correct?
Accountants and managers often set the optimal price by the cost plus rule:
( ) ( ) Given its widespread use one wonders if the cost plus rule is always correct (in the sense that it gives the same price as
the optimal price rule). No. Here is why. Compare the optimal price rule with the cost plus rule: ( ) Clearly, one of the conditions for the cost plus rule to be correct is: This happens when there are constant returns and
business is producing a high volume). (either because fixed costs are literally zero or because the Noting that: We see that the second condition for the cost plus rule to be correct is that the markup should be chosen inversely
proportional to price elasticity: a price sensitive market (high
) should have a low markup and a price insensitive
) should have a high markup. Any manager who chooses the markup without accounting for price
sensitivity is setting the wrong price.
9.6 A Practical Algorithm for Optimal Pricing
What if a company does not know its demand and cost functions? How can it set the optimal price without sol...
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This document was uploaded on 01/19/2014.
- Fall '14
- The Land