Pricing Products

The Meaning of Price

Price is both the money someone charges for a good or service and what the consumer is willing to give up to receive a good or service.

Learning Objectives

Differentiate between cost, customer’s view of price, and society’s view of price

Key Takeaways

Key Points

  • When you ask about the cost of a good or service, you’re really asking how much you will have to give up in order to get it.
  • For the business to increase value, it can either increase the perceived benefits or reduce the perceived costs. Both of these elements should be considered elements of price.
  • Viewing price from the customer’s perspective helps define value — the most important basis for creating a competitive advantage.
  • There are two different ways to look at the role price plays in a society; rational man and irrational man.

Key Terms

  • value: The degree of importance you give to something.

What does a Price Convey

Buying something means paying a price. But what exactly is “price? ”

  • Price is the money someone charges for a good or service. For example, an item of clothing will cost a certain amount of money. Or a computer specialist will charge a certain amount of money for fixing your computer.
  • Price is also that which you, a consumer, has to give up in order to receive a product or service. Price does not necessarily always mean money. Bartering is when you exchange goods or services in return for goods or services. For example, I teach you English in exchange for you teaching me about graphic design. In that case, I give up my time and knowledge.

Even though the question, “How much? ” could be phrased as “How much does it cost? ” price and cost are two different things. Whereas the price of a product is what you, the consumer has to pay to obtain it, the cost is what the business pays to make it. When you ask about the cost of a good or service, you’re really asking how much will you have to give up to get it.

Different Perspectives on Price

The perception of price differs based on the perspective from which it is being viewed.

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Louis Vuitton: Louis Vuitton sells luxury designer goods such as these suitcases. If Louis Vuitton merchandise was offered at low prices it might significantly undermine the brand value, much of which is based upon exclusivity.

The Customer’s View

A customer can either be the ultimate user of the finished product or a business that purchases components of the finished product. It is the customer that seeks to satisfy a need or set of needs through the purchase of a particular product or set of products. Consequently, the customer uses several criteria to determine how much they are willing to expend, or the price they are willing to pay, in order to satisfy these needs. Ideally, the customer would like to pay as little as possible.

For the business to increase value, it can either increase the perceived benefits or reduce the perceived costs. Both of these elements should be considered elements of price.

To a certain extent, perceived benefits are the opposite of perceived costs. For example, playing a premium price is compensated for by having this exquisite work of art displayed in one’s home. Other possible perceived benefits directly related to the price-value equations are:

  • Status
  • Convenience
  • The deal
  • Brand
  • Quality
  • Choice

Many of these benefits tend to overlap. For instance, a Mercedes Benz E750 is a very high-status brand name and possesses superb quality. This makes it worth the USD 100,000 price tag. Further, if one can negotiate a deal reducing the price by USD 15,000, that would be his incentive to purchase. Likewise, someone living in an isolated mountain community is willing to pay substantially more for groceries at a local store than drive 78 miles (25.53 kilometers) to the nearest Safeway. That person is also willing to sacrifice choice for greater convenience.

Increasing these perceived benefits are represented by a recently coined term, value-added. Providing value-added elements to the product has become a popular strategic alternative.

Perceived costs include the actual dollar amount printed on the product, plus a host of additional factors. As noted, perceived costs are the mirror-opposite of the benefits. When finding a gas station that is selling its highest grade for USD 0.06 less per gallon, the customer must consider the 16 mile (25.75 kilometer) drive to get there, the long line, the fact that the middle grade is not available, and heavy traffic. Therefore, inconvenience, limited choice, and poor service are possible perceived costs. Other common perceived costs include risk of making a mistake, related costs, lost opportunity, and unexpected consequences.

Ultimately, it is beneficial to view price from the customer’s perspective because it helps define value — the most important basis for creating a competitive advantage.

Society’s View

Price, at least in dollars and cents, has been the historical view of value. Derived from a bartering system (exchanging goods of equal value), the monetary system of each society provides a more convient way to purchase goods and accumulate wealth. Price has also become a variable society employs to control its economic health. Price can be inclusive or exclusive. In many countries, such as Russia, China, and South Africa, high prices for products such as food, health care, housing, and automobiles, means that most of the population is excluded from purchase. In contrast, countries such as Denmark, Germany, and Great Britain charge little for health care and consequently make it available to all.

There are two different ways to look at the role price plays in a society; rational man and irrational man. The former is the primary assumption underlying economic theory, and suggests that the results of price manipulation are predictable. The latter role for price acknowledges that man’s response to price is sometimes unpredictable and pretesting price manipulation is a necessary task.

Impacts of Supply and Demand on Pricing

The supply and demand model states that the price of a good will be the level where the quantity demanded equals the quantity supplied.

Learning Objectives

Apply the concept of supply and demand to price determination

Key Takeaways

Key Points

  • In the supply and demand model of price determination, there is never a surplus or shortage of goods at the equilibrium level. The market always settles at the point where supply equals demand.
  • If demand increases (decreases) and supply is unchanged, then it leads to a higher (lower) equilibrium price and quantity.
  • If supply increases (decreases) and demand is unchanged, then it leads to a lower (higher) equilibrium price and higher (lower) quantity.
  • If a price for a particular product goes up and the customer is aware of all relevant information, demand will be reduced for that product.
  • Demand-oriented pricing focuses on the nature of the demand curve for the product or service being priced.

Key Terms

  • demand-oriented pricing: A pricing model focused on the nature of the demand curve for the product or service being priced.
  • Supply and demand model: An economic model of price determination in a market.
  • demand curve: An economic model showing the quantity demanded at various price levels.

Supply, Demand, and Pricing

Supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers (at current price) will equal the quantity supplied by producers (at current price), resulting in an economic equilibrium of price and quantity.

The four basic laws of supply and demand are:

  1. If demand increases and supply remains unchanged, then it leads to higher equilibrium price and higher quantity.
  2. If demand decreases and supply remains unchanged, then it leads to lower equilibrium price and lower quantity.
  3. If supply increases and demand remains unchanged, then it leads to lower equilibrium price and higher quantity.
  4. If supply decreases and demand remains unchanged, then it leads to higher equilibrium price and lower quantity.

Equilibrium is defined as the price-quantity pair where the quantity demanded is equal to the quantity supplied, represented by the intersection of the demand and supply curves. Market equilibrium is a situation in a market when the price is such that the quantity that consumers wish to demand is correctly balanced by the quantity that firms wish to supply.

Economics assumes that the consumer is a rational decision maker and has perfect information. Therefore, if a price for a particular product goes up and the customer is aware of all relevant information, demand will be reduced for that product. Should price decline, demand would increase. That is, the quantity demanded typically rises causing a downward sloping demand curve. A demand curve shows the quantity demanded at various price levels.

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Price affected by supply and demand: The price P of a product is determined by a balance between production at each price (supply S) and the desires of those with purchasing power at each price (demand D). The diagram shows a positive shift in demand from D1 to D2, resulting in an increase in price (P) and quantity sold (Q) of the product.

As a seller changes the price requested to a lower level, the product or service may become an attractive use of financial resources to a larger number of buyers, thus, expanding the total market for the item. This total market demand by all buyers for a product type (not just for the company’s own brand name) is called “primary demand. ” Additionally, a lower price may cause buyers to shift purchases from competitors, assuming that the competitors do not meet the lower price. If primary demand does not expand and competitors meet the lower price, the result will be lower total revenue for all sellers.

Demand-oriented pricing focuses on the nature of the demand curve for the product or service being priced. The nature of the demand curve is influenced largely by the structure of the industry in which a firm competes. That is, if a firm operates in an industry that is extremely competitive, price may be used to some strategic advantage in acquiring and maintaining market share. On the other hand, if the firm operates in an environment with a few dominant players, the range in which price can vary may be minimal.