548 Part 7 Pricing Decisions
CHAPTER 18
PRICING CONCEPTS
CHAPTER OVERVIEW
Everyone knows the familiar routine when shopping, whether for basic groceries, a new outfit, or the
latest in electronics—an item is looked at and then its price is asked. Consumers will always be
fascinated with goods and services, but their final purchase decision is influenced primarily by one crucial
factor—how much does it cost?
So, to begin with, how are prices determined? Chapter 18 is the first of two chapters devoted to pricing
decision and strategies. A price is the exchange value of a good or service—it represents whatever that
product can be exchanged for in the marketplace. We all know from personal experience that price plays
a big part in deciding whether to purchase a product, and marketers understand its importance in the
consumer’s decision-making process. In other words, price directly affects a company’s overall
profitability and market share.
Changes in the 17th Edition
The chapter has been updated and revised in several ways, with a number of new features:
• The Opening Vignette and Evolution of a Brand discuss the success story of Dollar General, a
chain of variety stores with more than 11000 branches. “Dollar General Attracts Shoppers on
Price Points, Not Price,” gives the reader an insight into the strategies Dollar General adopts to
stay ahead of competition from other discount chains. Dollar General sells products in smaller
sizes, thus offering low price points which translate into higher profits. The chain primarily caters
to customers who can afford to buy only small amounts at a time and who also shop more
frequently.
Chapter 18 Pricing Concepts 549
market it as a minor luxury item. The details of this enterprise can be read in “The Pricey Smell of
Success.”
• Career Readiness offers advice on how to get the most out of your money when purchasing a
car. Read all about it in “Getting the Best Car Price.”
• Video Case includes an overview of pricing concepts used by Ski Butternut, a ski resort in
western Massachusetts.
LECTURE OUTLINE
Opening Vignette and Evolution of a Brand—“Dollar General Attracts Shoppers on Price
Points, Not Price.” Dollar General poses a threat to Walmart and other discount stores. How does
Dollar General’s strategy of selling smaller sizes of major brand-name products work?
Chapter Objective 1: Discuss the legal constraints on pricing.
Key Terms: price, tariffs, ticket-scalping, Robinson-Patman Act, price discrimination, unfair-trade
laws, fair-trade laws,
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1. What is pricing?
a. A price is the exchange value of a good or service,
representing what an item can be exchanged for in the
marketplace
b. Price doesn’t necessarily involve money, but at times
involves an exchange of goods, or barter
2. Pricing and the law
a. Pricing decisions are affected by legal constraints imposed
by federal, state, and local governments
i. Taxes levied on the sale of imported goods and
services—called tariffs—add to prices
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produced products into international markets at
prices lower than domestic levels
iv. While the average tariff on fruits and vegetable
imports is more than 50 percent, United States
levies minimal for most of its transactions and zero
tariffs on imports for its largest trading partners—
Mexico and Canada
3. Robinson-Patman Act
a. The Robinson-Patman Act was passed in 1936 due to
price competition triggered by the rise of grocery store
chains
b. It was an amendment to the Clayton Act, enacted 22 years
earlier, broader in scope and geography and prohibits
price discrimination in sales to wholesalers, retailers, and
other producers
i. It says differences in price must reflect cost
differentials
4. Unfair-trade laws
a. Unfair-trade laws, first enacted in the 1930s, require
sellers to maintain minimum prices for comparable
merchandise
b. Most states have supplemented federal laws with these
laws
c. They were to protect small shops from loss-leader pricing
used by chain stores that sell items below cost to attract
customers
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d. They’re rarely enforced today (with some exceptions)
5. Fair-trade laws
a. Fair-trade laws let manufacturers set minimum prices for
their products and require dealers to sign contracts
agreeing to these
Assessment check questions
1.1. What was the purpose of the Robinson-Patman Act? The Robinson-
1.2. What laws require sellers to maintain minimum prices for comparable
merchandise? At the state level, unfair-trade laws require sellers to
1.3. What laws allow manufacturers to set minimum retail prices for their
products? Fair-trade laws permit manufacturers to set minimum retail
Chapter Objective 2: Identify the four major categories of pricing objectives.
Key Terms: marginal analysis, profit maximization, target-return objective, market-share
objective, Profit Impact of Market Strategies (PIMS) project, value pricing, inexpensive, profit
1. Pricing objectives and the marketing mix
a. The extent to which the four factors of production—natural
resources, capital, human resources, and
entrepreneurship—are employed depends on the prices of
552 Part 7 Pricing Decisions
example for each of
the four pricing
objectives.
market share from higher-priced, options-laden
competitors by offering relatively low prices
e. While pricing objectives vary from firm to firm, they can be
classified into four major groups:
i. Profitability objectives
2. Profitability objectives
a. Profitability objectives refer to the fact that prices must be
set with profits in mind—even not-for-profits organizations
have to set prices high enough to meet expenses
b. Economic theory is based on two major assumptions:
i. That firms will behave rationally
ii. That this rational behavior will result in an effort to
maximize gains and minimize losses
c. Prices need to be regularly evaluated and adjusted due to
environmental changes and technological advances
d. Profits are a function of revenue and expenses, defined by
an approach called marginal analysis:
i. Profits = Revenues – Expenses
ii. Total revenue = Price x Quantity sold
iii. Profit-maximizing price rises to a point at which
further increases cause disproportionate decreases
in the number of units sold
3. Volume objectives
a. Volume objectives are based on the belief that pricing
seeks to maximize sales within a given profit constraint,
meaning if a minimum acceptable profit level is set,
marketers can then seek to maximize sales
b. Sales maximization can also result from nonprice factors
such as service and quality
Chapter 18 Pricing Concepts 553
organizations do to
address this pricing
Science Institute, found that the two most important
factors influencing profitability were product quality
and market share
4. Meeting competition objectives
a. Many firms base prices on meeting competition
objectives—simply match competitors’ prices, especially
those of established industry leaders
b. Pricing objectives tied directly to meeting competitors’
prices deemphasize price and focus strongly on nonprice
variables
i. However, pricing is a highly visible component of a
firm’s marketing mix—an easy and effective tool for
obtaining a differential advantage over competitors
c. Value pricing
i. When discounts are used in a competitive
marketplace, product value (not just price)
determines product choice
ii. Value pricing stresses benefits of a product in
comparison to price and quality levels of competing
offerings
5. Prestige objectives
a. Prestige pricing sets a high price to maintain an image of
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Table 18.2—
Distinguishing
Features of the Four
Market Structures.
Which structure has
structure allows for
the most control over
price?
Cost. Discuss how
prices fluctuate
based on these
factors.
c. Prestige objectives are unrelated to profitability or sales
volume
6. Pricing objectives of not-for-profit organizations
a. Profit maximization: not-for-profit organizations often try to
maximize their returns on a single event or a series of
events
7. Methods for determining prices
a. Marketers determine prices in two basic ways—by
applying the concepts of supply and demand, and by
completing cost-oriented analyses
i. During the first half of the 20th century, price was
b. Both methods overlook another concept of price
determination—customary prices
i. Customary prices are retail prices that consumers
expect as a result of tradition and social habit
ii. Some producers have tried to maintain prices, in
the face of rising costs, by reducing product size
8. Price determination in economic theory
a. Microeconomics suggests a way of determining prices that
assumes a profit-maximization objective. This technique
involves comparing supply and demand
i. Demand refers to a schedule of the amounts of a
firm’s product that consumers will purchase at
different prices during a specified time period
market structures
b. Four types of market structures—pure competition,
monopolistic competition, oligopoly, monopoly
i. Pure competition: many buyers and sellers
exchanging relatively homogeneous products, so
Chapter 18 Pricing Concepts 555
Table 18.3 Price
Determination Using
Marginal Analysis.
Discuss how profits
vary based on pricing
and numbers sold.
no single participant can significantly influence
price
ii. Monopolistic competition: large numbers of buyers
and sellers exchanging heterogeneous goods, so
marketers have some control over prices (typifies
most retailers)
restrictions
9. Cost and revenue curves
a. Marketers must set a price for a product that generates
sufficient revenue to cover the costs of producing and
marketing it
b. A product’s total cost is composed of total variable costs
and total fixed costs
i. Variable costs are those that change with the level
of production (such as labor and raw materials
costs)
ii. Fixed costs are those that remain stable at any
production level within a certain range (such as
lease payments or insurance costs)
c. The demand side of the pricing equation focuses on
revenue curves
d. Average revenue is calculated by dividing total revenue by
the quantity associated with these revenues
e. Average revenue is actually the demand curve facing the
firm
Assessment check questions
2.1. What are target-return objectives? Target-return objectives are short-
2.2. What is value pricing? Value pricing emphasizes the benefits a
2.3. How do prestige objectives affect a seller’s pricing strategy? Prestige
2.4. What goals does pricing strategy help a not–for-profit organization
achieve? Pricing strategy helps not-for-profit organizations achieve a
2.5. What are the two basic ways in which marketers determine prices?
2.6. What are the four types of market structures? The four types of
2.7. Identify the two types of costs that make up a product’s total cost. A
product’s total cost is composed of total variable costs and total fixed
costs.
Chapter Objective 3: Explain price elasticity and its determinants.
Key Terms: elasticity of demand, inelastic
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1. The concept of elasticity in pricing strategy
a. Elasticity is the measure of responsiveness of purchasers
and suppliers to price changes
1.0, then it is said to be elastic demand or supply;
similarly if it is less than 1.0 it is said to be inelastic
b. Determinants of elasticity
i. Elasticity of demand is affected by several factors:
ii. Availability of substitutes or complements (if
substitutes can be found, a product’s demand is
more elastic)
iii. The role of a product as a complement to another
product
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Assessment check questions
3.1. What are the determinants of elasticity? The degree of consumer
responsiveness to price changes—elasticity—is affected by such factors
as (1) availability of substitute or complementary goods, (2) the
3.2. What is the usual relationship between elasticity and revenue? A
price cut increases revenue only for a product with elastic demand, and
price increase raises revenue only for a product with inelastic demand.
Chapter Objective 4: Describe the three practical problems involved in applying price
theory concepts to actual pricing decisions.
Key Terms: none
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1. Practical problems of price theory
a. Certain practical considerations interfere with price theory,
or the process of evaluating and setting prices:
2. Although demand itself can be identified, it is often difficult to
measure in real-world settings
Assessment check question
4.1. List the three reasons why it is difficult to put price theory into
practice. A basic assumption of price theory is all firms attempt to
maximize profits. This does not always happen in practice. A second
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Chapter Objective 5: Explain the two major cost-plus approaches to price setting.
Key Terms: cost-plus pricing, full-cost pricing, incremental-cost pricing
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1. Price determination in practice
a. Cost-plus pricing is the most popular alternative to the
2. Alternative pricing procedures
a. Full-cost pricing
i. Full-cost pricing uses all relevant variable costs in
setting a product’s price
ii. Also, fixed costs that cannot be directly attributed
to the production of a specific item are allocated
b. Two deficiencies of the full-cost method:
i. There is no consideration of competition or
demand for the item
ii. Any method for allocating overhead—and other
fixed expenses—is arbitrary and may be unrealistic
c. Incremental-cost pricing
i. Incremental-cost-pricing attempts to use only costs
directly attributable to a specific output in setting
prices
ii. Helps overcome the arbitrary allocation of fixed
expenses
Assessment check questions
5.1. What is full-cost pricing? Full-cost pricing uses all relevant variable
5.2. What is incremental-cost pricing? Incremental-cost pricing attempts
to use only costs directly attributable to a specific output in setting prices
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to overcome the arbitrary allocation of fixed expenses.
Chapter Objective 6: Discuss the three shortcomings of using breakeven analysis in
pricing decisions.
Key Terms: breakeven analysis, modified breakeven analysis
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Figure 18.2
Breakeven Chart.
Discuss how the
number of units sold
1. Breakeven analysis
a. Breakeven analysis is a means of determining the number
of units of a product that must be sold at a given price to
generate sufficient revenue to cover total costs
b. The breakeven point in units:
Total fixed cost / Per-unit contribution to fixed cost
Breakeven (units) = 100,000/(10 – 8) = 50,000 units
Breakeven (dollars) = 100,000/[1 – (8/10)] = $500,000
e. Once the breakeven point has been reached, sufficient
2. Target returns
a. Most managers include a targeted profit in their analyses
when calculating the breakeven point
3. Evaluation of breakeven analysis
a. It is an effective tool for marketers in assessing the sales
required for covering costs and reaching certain profit
levels
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Discuss how the
modified concept
combines traditional
breakeven analysis
with an evaluation of
consumer demand.
Table 18.4 Revenue
and Cost Data for
Modified Breakeven
Analysis. Discuss
how price and
quantity affect
revenue and cost,
based on this
ii. It assumes that per-unit variable costs do not
change at different levels of operation
iii. It doesn’t consider demand
d. Pricing must be examined from the buyer’s perspective
and so cannot be fixed by considering only a firm’s cost
factors
4. The modified breakeven concept
a. In practice, most pricing approaches are largely cost
oriented, so modifications that add demand analysis to the
pricing decision are required
b. Marketing research is necessary to develop sales
demand
e. This concept summarizes both the cost and revenue
aspects of a number of alternative retail prices
f. Modified breakeven analysis gets marketers to consider
whether consumers are likely to buy the number of units
required for achieving breakeven at a given price
i. It demonstrates that selling a large number of units
does not automatically produce profits, because
Assessment check questions
6.1. What is the formula for finding the breakeven point, in units and in
dollars? Breakeven point (in units) = Total fixed cost/Per-unit contribution
to fixed cost. Breakeven point (in dollars) = Total fixed cost/(1 – Variable
cost per unit price).
6.2. What adjustments to the basic breakeven calculation must be made
to include target returns? Breakeven point (including specific dollar target
6.3. What are the advantages of breakeven analysis? Breakeven
6.4. What are the disadvantages of breakeven analysis? First, the model
assumes that cost can be divided into fixed and variable categories and
ignores the problems of arbitrarily making some allocations. Second, it
6.5. What is modified breakeven analysis? The modified breakeven
concept combines traditional breakeven analysis with an evaluation of
Chapter Objective 7: Explain the use of yield management in pricing decisions.
Key Terms: yield management
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1. Yield management
a. When a firm’s costs are fixed over a wide range of outputs,
the main factor determining profit will be amount of sales
revenue
b. Yield management strategies allow marketers to vary
prices based on such factors as demand, even though the
Assessment check questions
7.1. Explain the goal of yield management. Yield management pricing
strategies are designed to maximize revenues in situations in which costs
are fixed, such as airfares, auto rentals, and theater tickets.
Chapter Objective 8: Identify the five major pricing challenges facing online and
international marketers.
Key Terms: None
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1. Global issues in price determination
a. To be successful internationally, a firm needs to face the
challenge of setting prices in a global environment
2. Pricing objectives in global marketing
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a. Profitability
i. Marketers choose profitability objectives if their firm
is a price leader that tends to establish
understand that increased competition in many
international markets has spurred firms toward
meeting competitors’ prices
ii. For example, Europe’s widespread adoption of the
euro has become a driving force in price
convergence
d. Prestige
i. Prestige affects international pricing when products
are associated with intangible benefits such as
high quality, exclusiveness, or attractive design
e. Price stability
i. Price stability is desirable in international markets
but is difficult to achieve
ii. Environmental factors affect price stability, such as
war, terrorism, economic downturns, changes in
political parties and governments, and shifts in
trade policies
3. Strategic Implications of Marketing in the 21st Century
a. Pricing concepts are critical to all business, especially in e–
business which allows quick comparisons, on the spot
negotiations, auctions, and lets customers name the prices
b. Online price comparison engines, known as shopping