Chapter 13 – Building the Price Foundation
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LEARNING REVIEW
13-7. What is the difference between a movement along and a shift of a demand curve?
13-7. What is the difference between elastic demand and inelastic demand?
13-8. What is total revenue and how is it calculated?
IV. STEP 3: DETERMINING COST, VOLUME,
AND PROFIT RELATIONSHIPS
• Revenues are the monies received by the firm from selling its products to customers.
• Costs or expenses are the monies the firm pays out to its employees and suppliers.
• Marketers use marginal analysis and break-even analysis to relate revenues and costs.
A. The Importance of Controlling Costs [LO 13-5]
• Understanding the role and behavior of costs is critical for marketing decisions.
• [Figure 13-5] Five cost concepts are important in pricing decisions:
Chapter 13 – Building the Price Foundation
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a. Total cost (TC).
• Is the total expense incurred by a firm in producing and marketing a
product.
• Is the sum of fixed cost (FC) and variable cost (VC), or TC = FC + VC.
b. Fixed cost (FC).
• Is the sum of the expenses of the firm that are stable and do not change
c. Variable cost (VC).
• Is the sum of the expenses of the firm that vary directly with the quantity
d. Unit variable cost (UVC).
• Is variable cost expressed on a per unit basis, or…
• UVC = VC ÷ Q.
• Many firms go bankrupt because their costs get out of control, causing their total
costs to exceed their total revenues over an extended period of time.
B. Break-Even Analysis [LO 13-6]
• Marketing managers often employ an approach that considers cost, volume, and
profit relationships based on the profit equation.
• Break-even analysis is a technique that analyzes the relationship between total
revenue and total cost to determine profitability at various levels of output.
• The break-even point (BEP).
a. Is the quantity at which total revenue and total cost are equal.
[See CH13BreakEvenPoint.xls]
1. Calculating a Break-Even Point.
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Using the small picture frame store example in the text, a BEP quantity for the
number of pictures needed to be sold to cover fixed costs can be calculated. If FC
= $32,000, P = $120, and UVC = $40, the BEPQuantity is:
2. Developing a Break-Even Chart.
a. [Figure 13-6]
• The orange-shaded row shows that the break-even quantity at a price of
$120 per picture is 400 pictures.
• At less than 400 pictures, the picture frame store incurs a loss and at more
than 400 pictures, it makes a profit.
b. A break-even chart:
• Is a graphic presentation of the break-even analysis that shows when…
– Total revenue (green line DE) and total cost (blue line AC) intersect…
– To identify profit or loss for a given quantity sold.
– TR and TC are equal at a quantity of 400 pictures sold, which is the
break-even point (F) at which profit is exactly $0.
• If the quantity sold annually increases to 2,000 pictures:
– The graph in Figure 13-10A shows an annual profit earned of
$128,000 ($240,000 – $112,000 or line EC)…
– As shown by the row shaded in green in Figure 13-9.
Chapter 13 – Building the Price Foundation
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LEARNING REVIEW
13-10. What is the difference between fixed costs and variable costs?
13-11. What is a break-even point?
13-12. Why do firms add new technology and automation when they increase their fixed
costs?
Chapter 13 – Building the Price Foundation
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APPLYING MARKETING KNOWLEDGE
1. How would the price equation apply to the purchase price of (a) gasoline,
(b) an airline ticket, and (c) a checking account?
Answers:
2. What would be your response be to the statement, “Profit maximization is the only
legitimate pricing objective for the firm?”
3. How is a downward-sloping demand curve related to total revenue and marginal
revenue?
4. A marketing executive once said, “If the price elasticity of demand for your product is
inelastic, then your price is probably too low.” What is this executive saying in terms
of the economic principles discussed in this chapter?
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5. A marketing manager reduced the price on a brand of cereal by 10 percent and
observed a 25 percent increase in quantity sold. The manager then thought that if the
price were reduced by another 20 percent, a 50 percent increase in quantity sold
would occur. What would be your response to the marketing manager’s reasoning?
6. A student theater group at a university has developed a demand schedule that shows
the relationship between ticket prices and demand based on a student survey (see the
table that follows).
(a) Graph the demand curve and the total revenue curve based on these data.
What ticket price might be set based on this analysis?
[See CH13AMKQ6.xls]
Chapter 13 – Building the Price Foundation
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(b) What other factors should be considered before the final price is set?
7. Touché Toiletries, Inc., has developed an addition to its Lizardman Cologne line
tentatively branded Ode d’Toade Cologne. Unit variable costs are 45 cents for a
three-ounce bottle, and heavy advertising expenditures in the first year would result
in total fixed costs of $900,000. Ode d’Toade Cologne is priced at $7.50 for a three–
ounce bottle. How many bottles of Ode d’Toade must be sold to break even?
Answer:
[See CH13AMKQ7.xls]
8. Suppose that marketing executives for Touché Toiletries reduced the price to $6.50
for a three-ounce bottle of Ode d’Toade and the fixed costs were $1,100,000. Suppose
further that the unit variable cost remained at 45 cents for a three-ounce bottle.
(a) How many bottles must be sold to break even? (b) What dollar profit level would
Ode d’Toade achieve if 200,000 bottles were sold?
Answers:
[See CH13AMKQ8.xls]
[See CH13AMKQ8.xls]
13–28
9. Executives of Random Recordings, Inc., produced a digital album entitled
Sunshine/Moonshine by the Starshine Sisters Band. (a) Using the price and cost
information in the table, prepare a chart like that in Figure 13-10 showing total cost,
fixed cost, and total revenue for album quantity sold levels starting at 10,000 through
100,000 digital albums at 10,000 intervals, that is, 10,000; 20,000; 30,000; and so on.
(b) What is the break-even point for the digital album?
Answer:
[See CH13AMKQ9.xls]
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BUILDING YOUR MARKETING PLAN
In starting to set a final price:
1. List two pricing objectives and three pricing constraints.
2. Think about your customers and competitors and set three possible prices.
3. Assume a fixed cost and unit variable cost and (a) calculate the break-even points and
(b) plot a break-even chart for the three prices specified in step 2.
Helping with Common Student Problems
“But I don’t know what the fixed costs for a flower shop are going to be” is a common
student complaint. The simple instructor answer: “Well then you’d better do some data digging
and make some simple assumptions. And by the way, please put those assumptions in your plan
so we know your starting point.”
Probably the biggest surprise from students in the hundreds of marketing plans we’ve
read and graded is: How many more widgets they have to sell than they expected—just to start
Chapter 13 – Building the Price Foundation
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TEACHING NOTE FOR VIDEO CASE VC-13
Washburn Guitars: Using Break-Even Points to Make Pricing Decisions
Synopsis
Washburn Guitar manufactures instruments in four categories—one-of–a-kind, batch
custom, mass customized, and mass produced—and must set prices in each category that
enable it to stay in business. Bill Abel, Washburn’s VP of sales, is responsible for setting the
prices for the firm’s guitar lines. Looking at a new line whose suggested retail price is $349,
Abel estimates elements of Washburn’s fixed and variable costs to project the likely break–
even point and profit. Students calculate break-even points and profits under various
conditions and assess the effects of moving two production facilities to a single new location.
Teaching Suggestions
Before assigning this case, instructors should review key terms and equations defined and
explained in Chapter 13: Price (P), Total Revenue (TR), Total Cost (TC), Fixed Costs (FC),
Variable Costs (VC), Unit Variable Costs (UVC), and Break-Even Point (BEP). Also, ask
students the following questions:
1. What is a break-even point? How do you calculate it?
2. What is the profit equation?
Answers to Questions
1. What factors are most likely to affect the demand for the lines of Washburn guitars
(a) bought by a first-time guitar buyer and (b) bought by a sophisticated musician
who wants a signature model.
Answers:
Chapter 13 – Building the Price Foundation
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2. For Washburn, what are examples of (a) shifting the demand curve to the right to get
a higher price for a guitar line (movement of the demand curve) and (b) pricing
decisions involving moving along a demand curve.
Answers:
3. In Washburn’s factory, what is the break-even point for the new line of guitars if the
retail price is (a) $349, (b) $389, and (c) $309? Also, (d) if Washburn achieves the
sales target of 2,000 units at the $349 retail price, what will its profit be?
Answers:
Chapter 13 – Building the Price Foundation
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4. Assume that the merger with Parker leads to the cost reductions projected in the case.
What will be the (a) new break-even point at a $349 retail price for this line of guitars
and (b) new profit if it sells 2,000 units?
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5. If for competitive reasons, Washburn eventually has to move all its production back
to Asia, (a) which specific costs might be lowered and (b) what additional fixed and
variable costs might it expect to incur?
Answers: