# Chapter 12 Pricing Discrimination

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```					LO 1 Use differential analysis to analyze decisions

Used in comparison of alternative selection
short run versus long run (see LO2 and LO3)
some cost cannot be changed in short run, while all costs can be changed in long run
Essential idea is to compare things that differ between the alternatives
differential costs
sunk costs
differential cost versus total cost (can use both)

LO2 Understand how to apply differential analysis to pricing decisions

short run decisions
one-time special order (see example in textbook)
decision is based upon \$, any other items to consider?
long run decisions
adjusting product mix or volume in competitive market

LO3 Understand several approaches for establishing prices based on cost for long-run pricing decisions
Full cost to determine price
Differential cost differs between short run and long run time horizon
Methods to establishing prices
Life-Cycle product costing and pricing
Target costing
Target pricing
Issues related to pricing
predatory pricing
dumping
price discrimination
price fixing

LO4 Understand how to apply differential analysis to production decisions

product choice (mix) decisions

LO5 Understand the theory of constraints

Assume organizations have limits on what they can accomplish
Based upon these limits, organizations can maximize profit by
determining a product mix that maximizes contribution margin per unit of
constraining resource.
Difference between a sunk and differential cost

A sunk cost has taken place in the past and cannot be changed. A differential cost is one that will change with
erential cost is one that will change with a given decision.
SPECIAL ORDER
current pro forma

Sales Revenues                                  18,000 \$6 per unit               3000
costs of meals produced                         13,500
GP                                               4,500
operating profit                                 2,400

Special olympics is willing to purchase 300 meals for \$3.50

SHOULD SPECIAL ORDER BE ACCEPTED?

First separate into variable and fixed costs
\$4,500 meal production

Status Quo        Special Order   Difference
quantity                                      3,000           3,300
Sales Revenues                                   18,000          19,050         1,050
Variable Cost
meal costs                                   9,000            9,900           900
-
-
Total Variable Costs                            10,500           11,400           900
CM                                               7,500            7,650           150
Fixed Costs
meal costs                                   4,500            4,500           -
Total Fixed Costs                                5,100            5,100           -
Operating Profit                                 2,400            2,550           150

Intangibles
Qualitative
Price = \$21

operating profit = 20% of costs

WHAT IS HIGHEST ACCEPTABLE COSTS?

price - costs = profit

price - costs = (.2 X costs)

price = (.2 X costs) + costs

price = 1.2 costs

costs = price / 1.2

costs = 21/ 1.2

costs = 17.5

COMPARE OPERATING PROFIT = 20%

price - costs = profit

how to make %

(price - costs)/ price = profit / price

price / price - costs / price = profit / price

cost / price = 1 - profit / price

cost = price * (1 - profit / price)

cost = 21 * (1 - .2)

cost = 21 * .8

cost = 16.80
costs to make
materials                                 0.20          (0.20)
labor                                     0.15          (0.15)
variable o/h                              0.15          (0.15)
0.60          0.50           0.10

Is there any ethical considerations?
machine 2     machine 1
cartridge       holder
monthly capacity           800,000      1,000,000
monthly production         800,000        800,000
price                            10
variable cost                      4

fixed costs               4,000,000

Company could sell 1,000,000 pens per month

a) bottleneck?          machine 2

b) produce on the weekend?

produce 200,000 more
+\$1 variable costs
+\$800,000 fixed costs

Status Quo   weekend       Difference
800,000    1,000,000
Sales Revenues                          8,000,000   10,000,000     2,000,000
Variable Cost
cartridge                              3,200,000     4,200,000    1,000,000
-
-
-
Total Variable Costs                    3,200,000     4,200,000    1,000,000
CM                                      4,800,000     5,800,000    1,000,000
Fixed Costs
4,000,000     4,800,000      800,000
-
Total Fixed Costs                       4,000,000     4,800,000      800,000
Operating Profit                          800,000     1,000,000      200,000

produce 100,000 more
+\$4.50 variable costs
+\$0 fixed costs

Status Quo   + weekday     Difference
800,000       900,000
Sales Revenues         8,000,000   9,000,000   1,000,000
Variable Cost
3,200,000   4,050,000    850,000
-
-
-
Total Variable Costs   3,200,000   4,050,000    850,000
CM                     4,800,000   4,950,000    150,000
Fixed Costs
4,000,000   4,000,000        -
-
Total Fixed Costs      4,000,000   4,000,000        -
Operating Profit         800,000     950,000    150,000

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