PRICING by MrMcGowan



The price a firm sets for its products/services will affect demand.

Demand Curve         Fig. 1
                                                       The Demand curve shows us the
                                                       relationship between price and
                                                       the quantity demanded.

                                                       As we can see when the price
                                                       increases from P1 to P2, then the
                                                       Quantity demanded falls from
                                                       Q1 to Q2.

                                                       When goods or services respond
                                                       strongly to changes in price, they
                                                       can be deemed price sensitive.

Price is important for two main reasons:
    1. Consumers will only pay what they can afford
    2. Consumers use price as a measure of quality

How do small firms set their price?

Small firms usually use cost-based pricing methods
called mark-ip and cost-plus pricing. For example, A
small clothes shop buys a dress for £40.

Mark-up – adds a profit percentage onto direct cost of goods, so if the dress is to
have a 100% mark-up, the £40 dress will be sold at £80.

Cost-plus pricing – this is similar to mark-up but adds overheads onto direct costs
before the profit percentage is added.

Long Term Pricing Strategies

Low Price – businesses may charge a lower price than those of competitors if the good
is price sensitive. This is when consumers respond positively to changes in price, and
lower may result in higher sales.

Market Price – when a business sets prices in line with competitors. This avoids a price
war, which is unbeneficial to all companies.

High Price – adopted by firms offering high quality, premium goods and services, where
image is all important.

M. McGowan
Short Term Pricing Strategies

Skimming – when a new product is introduced the price is set high. At the beginning
when competition is low, consumers pay for the novelty value. As more competition
enters the price is lowered each time to ‘skim the cream’ off the market. This occurs in
technological markets. When DVD players first came out in the late 1990s they cost in
excess of £1,000. Today cheap DVDs can be bought for around £80.

Penetration Pricing – used when entering an established market, it allows sales and
market share to increase quickly. Prices are set low, sometimes at a loss. As the
product becomes established it can then increase the price. Stagecoach introduced low
fares when entering the Glasgow market in 1997 to take passengers from First Bus.

Destroyer pricing is when a firm sets a price low enough to drive competitors out of
the market. Once the competitor is forced out, prices can return to normal. It is
deemed anti-competitive by the Government. Rentokill advertised competitive prices
nationwide, but reduced prices occasionally at local level to put local firms out of

Promotional pricing is used in the short term to boost sales or create interest in a new
product. Supermarkets may lower the price of their best selling products in order to
attract customers who will buy other goods while in the store. This is also called a loss
leader - a product that has a price set so low that it acts as a promotional device and
draws customers into the store.

Demand-orientated pricing refers to varying the price for different groups of
consumers. For example telephone calls are less expensive off peak as there are less
calls made during that period. It is a way of generating more business. This is also
called price discrimination.


   1. What does the demand curve show?
   2. Explain the difference between mark-up pricing and cost-plus pricing?
   3. Describe the three long term pricing strategies.
   4. What is market skimming? What types of firms would use this strategy?
   5. Compare and contrast penetration pricing and destroyer pricing.
   6. Explain what promotional pricing is. Give an example of a good which you have
      bought recently which would be priced in this way.
   7. Describe demand-orientated pricing. Give an example of a good or service which
      could use demand-orientated pricing.

M. McGowan

To top