MANAGERIAL ECONOMICS AND FINANCIAL ANALYSIS

UNIT – III : Business Organizations and Markets

Introduction – Nature, meaning, significance, functions and advantages. Forms of Business

Organizations - Sole Proprietary - Partnership - Joint Stock Companies - Public Sector
Enterprises.
Types of Markets - Perfect and Imperfect Competition - Features of Perfect Competition -
Monopoly - Monopolistic Competition–Oligopoly-Price-Output Determination - Pricing
Methods and Strategies

Factors affecting the choice of form of business organization

The following are the factors affecting the choice of a business organization:
1. Easy to start and easy to close: The form of business organization should be such
that it should be easy to close. There should not be hassles or long procedures in the process
of setting up business or closing the same.
2. Division of labour: There should be possibility to divide the work among the available
owners.
3. Large amount of resources: Large volume of business requires large volume of
resources. Some forms of business organization do not permit to raise larger resources.
Select the one which permits to mobilize the large resources.
4. Liability: The liability of the owners should be limited to the extent of money invested
in business. It is better if their personal properties are not brought into business to make
up the losses of the business.
5. Secrecy: The form of business organization you select should be such that it should
permit to take care of the business secrets. We know that century old business units are
still surviving only because they could successfully guard their business secrets.
6. Transfer of ownership: There should be simple procedures to transfer the ownership
to the next legal heir.
7. Ownership, Management and control: If ownership, management and control are in
the hands of one or a small group of persons, communication will be effective and
coordination will be easier. Where ownership, management and control are widely
distributed, it calls for a high degree of professional’s skills to monitor the performance of
the business.
8. Taxation: More profit means more tax. Choose such a form of business organisation,
which permits to pay low tax.

SOLE PROPRIETORSHIP

The sole proprietorship is the simplest, oldest and natural form of business organization. It
is also called sole trading concern. ‘Sole’ means one. ‘Sole trader’ implies that there is only
one trader who is the owner of the business.
The sole trader assumes all the risk of ownership carrying out the business with his
own capital, skill and intelligence. He is the owner, Manager and controller. He has total
freedom and flexibility. He can take his own decisions. He can choose or drop a particular
product or business based on its merits. This form of organization is popular all over the
world. Restaurants, Supermarkets, medical shops, Textile shops etc. are examples of sole
proprietorship business.
Features
• It is easy to start a business under this form and also easy to close.
• He introduces his own capital. Sometimes, he may borrow, if necessary
• He enjoys all the profits and in case of loss he alone suffers.
• He has unlimited liability which implies that his liability extends to his personal
properties in case of loss.
• He has a high degree of flexibility to shift from one business to the other.
• Business secretes can be guarded well
• There is no continuity. The business comes to a close with the death, illness or
insanity of the sole trader. Unless, the legal heirs show interest to continue the
business.
• He can take decisions very fast and implement them promptly.

Advantages

The following are the advantages of the sole trader from of business organization:
1. Easy to start and easy to close: Formation of a sole trader from of organization is
relatively easy even closing the business is easy.
2. Personal contact with customers directly: Based on the tastes and preferences of
the customers the stocks can be maintained.
3. Prompt decision-making: To improve the quality of services to the customers, he can
take any decision and implement the same promptly. He is the boss and he is responsible
for his business Decisions relating to growth or expansion can be made promptly.
4. High degree of flexibility: Based on the profitability, the trader can decide to continue
or change the business, if need be.
5. Secrecy: Business secrets can well be maintained because there is only one trader.
6. Direct motivation: If there are profits, all the profits belong to the trader himself. In
other words. If he works more hard, he will get more profits. This is the direct motivating
factor. At the same time, if he does not take active interest, he may stand to lose badly
also.
7. Total Control: The ownership, management and control are in the hands of the sole
trader and hence it is easy to maintain the hold on business.
8. Minimum interference from government: Except in matters relating to public
interest, government does not interfere in the business matters of the sole trader. The sole
trader is free to fix price for his products/services if he enjoys monopoly market.

Disadvantages

The following are the disadvantages of sole trader form:

1. Unlimited liability: The liability of the sole trader is unlimited. It means that the sole
trader has to bring his personal property to clear off the loans of his business. From the
legal point of view, he is not different from his business.
2. Limited amounts of capital: The resources a sole trader can mobilize cannot be very
large and hence this naturally sets a limit for the scale of operations.
3. No division of labour: All the work related to different functions such as marketing,
production, finance, labour and so on has to be taken care of by the sole trader himself.
4. Uncertainty: There is no continuity in the duration of the business. On the death,
insanity of insolvency the business may be come to an end.
5. More competition: Because it is easy to set up a small business, there is a high degree
of competition among the small businessmen and a few who are good in taking care of
customer requirements along can service.

PARTNERSHIP

Two or more persons join together to do the business and share the profits/losses of
the business in an agreed ratio is called as partnership form of business. Persons who have
entered into such an agreement are individually called as ‘partners’ and collectively called
as ‘firm’. The relationship among partners is called a partnership.
Indian Partnership Act, 1932 defines partnership as “The relationship between two
or more persons who agree to share the profits of the business carried on by all or any one
of them acting for all.”
Features
• Partnership is a relationship among persons resulting out of partnership deed(The
written agreement among the partners).
• There should be two or more number of persons.
• Business should be conducted.
• They should agree to share the profits/losses of the business
• Carried on by all or any one of them acting for all
• The liability of the partners is unlimited.
Advantages
The following are the advantages of the partnership from:
1. Easy to form: Once there is a group of like-minded persons and good business proposal,
it is easy to start and register a partnership.
2. Availability of larger amount of capital: More amount of capital can be raised from
more number of partners.
3. Division of labour: The different partners come with varied backgrounds and skills. This
facilities division of labour.
4. Flexibility: The partners are free to change their decisions, add or drop a particular
product or start a new business or close the present one and so on.
5. Personal contact with customers: There is scope to keep close monitoring with
customers requirements by keeping one of the partners in charge of sales and marketing.
6. Quick decisions and prompt action: If there is consensus among partners, it is
enough to implement any decision and initiate prompt action.
Disadvantages:
The following are the disadvantages of partnership:
1. Formation of partnership is difficult: Only like-minded persons can start a
partnership business. It is difficult to find a right business partner’.
2. Liability: The partners have joint and several liabilities beside unlimited liability. The
personal properties of the partner or partners can be attached to pay firms’ loans.
3. Lack of Faith: There will be in mutual conflicts, an attitude of suspicion and crisis of
confidence. Lack of harmony results in delay in decisions and paralyses the entire
operations.
4. Instability: The partnership form is known for its instability. The firm may be dissolved
on death, insolvency or insanity of any of the partners.
 JOINT STOCK COMPANY

The joint stock company emerges from the limitations of partnership such as unlimited
liability, limited resources and uncertain duration and so on.
Joint stock company means, people come together to earn by investing in the shares of
company jointly.
Joint stock company is from of organization as ‘an association of many persons who
contribute money or money’s worth to a common stock and employ it for a common
purpose.

Features

• It is an artificial person created by law.

• It has separate legal existence from its shareholders.
• The Company is an association of voluntary association of persons who want to carry
on business for profit.
• The shareholders have limited liability i.e., liability limited to the face value of the
shares held by him.
• Capital of the company is divided into shares
• The shares can be transferred from one person to the other
• As the company is an artificial person created by law it cannot sign its name on a
paper; so, it has a common seal on which its name is engraved.
• A company has uninterrupted existence because of the right given to the
shareholders to transfer the shares.
• Ownership and Management is separated
• It is necessary that the name of the company ends with limited (Ltd.) in case of public
limited company, (Pvt. Ltd).

Formation of Joint Stock company

There are two stages in the formation of a joint stock company. They are:
(a) To obtain Certificates of Incorporation
(b) To obtain certificate of commencement of Business
Certificate of Incorporation: The certificate of Incorporation is just like a ‘date of birth’
certificate. It certifies that a company with such and such a name is born on a particular
day.
Certificate of commencement of Business: A private company need not obtain the
certificate of commencement of business. It can start its commercial operations
immediately after obtaining the certificate of Incorporation.
The persons who conceive the idea of starting a company and who organize the
necessary initial resources are called promoters. The promoters have to file the following
documents, along with necessary fee, with a registrar of joint stock companies to obtain
certificate of incorporation:
(a) Memorandum of Association: The Memorandum of Association is also called the charter
of the company. It outlines the relations of the company with the outsiders. If furnishes all
its details in six clause such as (ii) Name clause (II) situation clause (iii) objects clause (iv)
Capital clause and (vi) subscription clause duly executed by its subscribers.
(b) Articles of association: Articles of Association furnishes the byelaws or internal rules
government the internal conduct of the company.
(c) The list of names and address of the proposed directors and their willingness, in writing
to act as such, in case of registration of a public company.
(d) A statutory declaration that all the legal requirements have been fulfilled. The
declaration has to be duly signed by any one of the following: Company secretary in whole
practice, the proposed director, legal solicitor, chartered accountant in whole time practice
or advocate of High court.
The registrar of joint stock companies peruses and verifies whether all these
documents are in order or not. If he is satisfied with the information furnished, he will
register the documents and then issue a certificate of incorporation, if it is private company,
it can start its business operation immediately after obtaining certificate of incorporation.
Advantages
The following are the advantages of a joint Stock Company
1. Mobilization of larger resources: A joint stock company provides opportunity for the
investors to invest, even small sums, in the capital of large companies. The facilities rising
of larger resources.
2. Separate legal entity: The Company has separate legal entity. It is registered under
Indian Companies Act, 1956.
3. Limited liability: The shareholder has limited liability in respect of the shares held by
him. In no case, does his liability exceed more than the face value of the shares allotted to
him.
4. Transferability of shares: The shares can be transferred to others. However, the
private company shares cannot be transferred.
5. Liquidity of investments: By providing the transferability of shares, shares can be
converted into cash.
6. Democracy in management: the shareholders elect the directors in a democratic way
in the general body meetings. The shareholders are free to make any proposals, question
the practice of the management, suggest the possible remedial measures, as they perceive,
The directors respond to the issue raised by the shareholders and have to justify their
actions.
7. Continued existence: The Company has perpetual succession. It has no natural end.
It continues forever and ever unless law put an end to it.
8. Professional management: With the larger funds at its disposal, the Board of Directors
recruits competent and professional managers to handle the affairs of the company in a
professional manner.
9. Growth and Expansion: With large resources and professional management, the
company can earn good returns on its operations, build good amount of reserves and further
consider the proposals for growth and expansion.
Disadvantages
1. Formation of company is a long procedure: Promoting a joint stock company
involves a long procedure. It is expensive and involves large number of legal formalities.
2. High degree of government interference: The government brings out a number of
rules and regulations governing the internal conduct of the operations of a company such
as meetings, voting, audit and so on, and any violation of these rules results into statutory
lapses, punishable under the companies act.
3. Delays in decision-making: As the size of the organization grows, the number of levels
in organization also increases in the name of specialization. The more the number of levels,
the more is the delay in decision-making.
4. Lack of responsibility and commitment: In some cases, the managers at different
levels are afraid to take risk and more worried about their jobs rather than the huge funds
invested in the capital of the company lose the revenue.
PUBLIC SECTOR ENTERPRISES
The business units owned, managed and controlled by the central, state or local
government are termed as public sector enterprises or public enterprises. These are also
known as public sector undertakings.
A public sector enterprise may be defined as any commercial or industrial undertaking
owned and managed by the central/state/local government with a view to maximise social
welfare and uphold the public interest.

Features of Public Sector Enterprises

1. Government Ownership and Management: The public enterprises are owned and
managed by the central or state government, or by the local authority. The
government may either wholly own the public enterprises or the ownership may
partly be with the government and partly with the private industrialists and the
public. For example, National Thermal Power Corporation (NTPC)
2. Financed from Government Funds: The public enterprises get their capital from
Government Funds and the government has to make provision for their capital in its
budget.
3. Public Welfare: Public enterprises are not guided by profit motive. Their major focus
is on providing the service or commodity at reasonable prices. Take the case of Indian
Oil Corporation or GAIL India Limited. They provide petroleum and gas at subsidised
prices to the public.
4. Public Utility Services: Public sector enterprises concentrate on providing public
utility services like transport, electricity, telecommunication etc.
5. Public Accountability: Public enterprises are governed by public policies formulated
by the government and are accountable to the legislature.
6. Excessive Formalities: The government rules and regulations force the public
enterprises to observe excessive formalities in their operations. This makes the task
of management very sensitive and cumbersome.
Forms of Public Sector Enterprises
 MARKET STRUCTURE & TYPES OF MARKETS

Market is a place where buyer and seller meet, goods and services are offered for
the sale and transfer of ownership occurs. Economists describe a market as a collection of
buyers and sellers who transact over a particular product or service. A market consists of
all firms and individuals who are willing and able to buy or sell a particular product. This
includes firms and individuals currently engaged in buying and selling a particular product,
as well as potential entrants.

The determination of price for a commodity or service depends upon the structure of
the market for that commodity or service (i.e., competitive structure of the market). Hence
the understanding on the market structure and the nature of competition are a pre-requisite
in price determination.

1. MONOPOLY
The word monopoly is made up of two syllables, Mono and poly. Mono means single while
poly implies selling. Thus monopoly is a form of market organization in which there is only
one seller of the commodity. There are no close substitutes for the commodity sold by the
seller. Pure monopoly is a market situation in which a single firm sells a product for which
there is no good substitute.

Features of Monopoly

1. Single person or a firm: A single person or a firm controls the total supply of the
commodity. There will be no competition for monopoly firm. The monopolist firm is the only
firm in the whole industry.

2. No close substitute: The goods sold by the monopolist shall not have closely
competition substitutes. Even if price of monopoly product increase people will not go in far
substitute.

3. Large number of Buyers: Under monopoly, there may be a large number of buyers in
the market who compete among themselves.

4. Price Maker: Since the monopolist controls the whole supply of a commodity, he is a
price-maker, and then he can alter the price.

5. Supply and Price: The monopolist can fix either the supply or the price. He cannot fix
both. If he charges a very high price, he can sell a small amount. If he wants to sell more,
he has to charge a low price.

6. Downward Sloping Demand Curve: The demand curve (average revenue curve) of
monopolist slopes downward from left to right. It means that he can sell more only by
lowering price.
Price and Output Determination in Monopoly Market

• In monopoly, there is only one producer of a product, who influences the price of the
product by making Change in supply.
• The producer under monopoly is called monopolist. If the monopolist wants to sell
more, he can reduce the price of a product. On the other hand, if he is willing to sell
less, he can increase the price.
 • As we know, there is no difference between organization and industry under
monopoly. Accordingly, the demand curve of the organization constitutes the demand
curve of the entire industry.
• The demand curve of the monopolist is Average Revenue (AR), which slopes
downward.

(MC = Marginal Cost; AC = Average Cost; MR = Marginal Revenue; AR = Average Revenue)

The equilibrium, under monopoly, is attained at the point where profit is maximum
that is where MR=MC. Therefore, the monopolist will go on producing additional units of
output as long as MR is greater than MC, to earn maximum profit. if output is increased
beyond OQ, MR will be less than MC. Thus, if additional units are produced, the organization
will incur loss. At equilibrium point, total profits earned are equal to shaded area ABEC. E
is the equilibrium point at which MR=MC with quantity as OQ.

2. PERFECT COMPETETION

Perfect competition refers to a market structure where competition among the sellers
and buyers prevails in its most perfect form. In a perfectly competitive market, a single
market price prevails for the commodity, which is determined by the forces of total demand
and total supply in the market.
Characteristics of Perfect Competition
The following features characterize a perfectly competitive market:
1. A large number of buyers and sellers: The number of buyers and sellers is large and
the share of each one of them in the market is so small that none has any influence on the
market price.
2. Homogeneous product: The product of each seller is totally undifferentiated from those
of the others.
3. Free entry and exit: Any buyer and seller are free to enter or leave the market of the
commodity.
4. Perfect knowledge: All buyers and sellers have perfect knowledge about the market
for the commodity.
5. Indifference: No buyer has a preference to buy from a particular seller and no seller to
sell to a particular buyer.
6. Non-existence of transport costs: Perfectly competitive market also assumes the
non-existence of transport costs.
7. Perfect mobility of factors of production: Factors of production must be in a position
to move freely into or out of industry and from one firm to the other.

Price and Output Determination in Perfect Competition Market

In a perfect competition, sellers and buyers are fully aware about the current market
price of a product. Therefore, the buyers and sellers cannot influence the market price by
increasing or decreasing their purchases or output, respectively. The market price of
products in perfect competition is determined by the industry. This implies that in perfect
competition, the market price of products is determined by taking into account two market
forces, namely market demand and market supply.
Market demand is defined as a sum of the quantity demanded by each individual
organizations in the industry. On the other hand, market supply refers to the sum of the
quantity supplied by individual organizations in the industry.
In perfect competition, the price of a product is determined at a point at which the
demand and supply curve intersect each other. This point is known as equilibrium point as
well as the price is known as equilibrium price.
D is the demand curve and SS is the supply curve, they equilibrate at point E and set the
market price as OP. Under perfect competition, firms adopt OP as the industry price.

• If MR > MC, the firm has an incentive to expand its production and sell
additional units.

• If MR < MC, the firm must reduce the output since additional units add more
cost than revenue.

• The firm gets maximum profits only when MR = MC.

 3. MONOPOLISTIC COMPETITION
In monopolistic competition, the market has features of both perfect competition
and monopoly. A monopolistic competition is more common than pure competition or pure
monopoly.

Monopolistic competition is a market in which firms can enter freely each producing
its own brand or a differentiated product. Thus, a firm under monopolistic competition

a) Enjoys ‘monopoly position’ as far as a particular brand is concerned.

b) Since the various brands are close substitutes, its monopoly position is influenced by the
perfect ‘competition’ from other firms.

The market for soaps and detergents in India. There are many well-known brands like
Lux, Rexona, Dettol, Dove, Pears, etc. in this segment. Since all manufacturers produce soaps,
it appears to be an example of perfect competition. However, on close scrutiny, we find that
each seller varies the product slightly to make it different from its competitors.
Hence, Lux focuses on making beauty soaps, Liril on freshness, Dettol on antiseptic
properties, Dove on smooth skin, etc. This allows each seller to attract buyers to itself based
on some factor other than price. This market has a mix of both perfect competition and
monopoly and is a classic example of monopolistic competition.

Characteristics of Monopolistic Competition

1. Large Number of Sellers: There are large number of sellers producing differentiated
products. So, competition among them is very keen. Since number of sellers is large,
each seller produces a very small part of market supply. Every firm is limited in its size.
2. Product Differentiation: Product differentiation refers to differentiating the products
on the basis of brand, size, colour, shape, etc. The product of a firm is close, but not
perfect substitute for products of other firms. Here, every producer tries to keep his
product dissimilar than his rival’s product in order to maintain his separate identity.
3. Freedom of Entry and Exit: This feature leads to stiff competition in market. Free
entry into the market enables new firms to come with close substitutes. Free entry or
exit maintains normal profit in the market for a longer span of time.
4. Selling Cost: It is a unique feature of monopolistic competition. In such type of market,
due to product differentiation, every firm has to incur some additional expenditure in
the form of selling cost. This cost includes sales promotion expenses, advertisement
expenses, salaries of marketing staff, etc.
5. Absence of Interdependence: Large numbers of firms are different in their size. Each
firm has its own production and marketing policy. So no firm is influenced by other firm.
All are independent.
6. Two-dimensional Competition: Monopolistic competition has two types or aspects of
competition viz. Price competition i.e. firms compete with each other on the basis of
price. Nonprice competition i.e. firms compete on the basis of brand, product quality
advertisement.
7. Concept of Group: Chamberlin introduced the concept of Group under monopolistic
competition. An industry means a number of firms producing identical product. A group
means a number of firms producing differentiated products which are closely related.
8. Lack of Perfect Knowledge: Buyers and sellers do not have perfect knowledge about
the market conditions. Selling costs create artificial superiority in the minds of the
consumers and it becomes very difficult for a consumer to evaluate different products
available in the market. As a result, a particular product (although highly priced) is
preferred by the consumers even if other less priced products are of same quality.
Price and Output Determination in Monopolistic Competition Market
Under monopolistic competition, organizations need to make optimum adjustments
in the prices and output sold to attain equilibrium. Apart from this, under monopolistic
competition, organizations also need to pay attention toward the design of the product and
the way the product is promoted in the market.

In monopolistic competition, profits are maximized at a point where marginal

revenue is equal to marginal cost (MR=MC). The price determined at this point is known as
equilibrium price and the output produced at this point is called equilibrium output.

Equilibrium in Short Run:

The short-run equilibrium of a monopolistic competitive organization is the same as

that of an organization under monopoly. In the short run, an organization under
monopolistic competition attains its equilibrium where marginal revenue equals marginal
cost and sets its price according to its demand curve. This implies that in the short run,
profits are maximized when MR=MC.

Equilibrium in Long Run:

In the long run, there is a gradual decrease in the profits of organizations. This is
because in the long run, several new organizations enter the market due to freedom of
entry and exit under monopolistic competition.

When these new organizations start production, the supply would increase and the
prices would fall. This would automatically increase the level of competition in the market.
Consequently, AR curve shifts from right to left and supernormal profits are replaced with
normal profits.

In the long run, the AR curve is

more elastic than that of in the short
run. This is because of an increase in the
number of substitute products in the
long- run. The long-run equilibrium of
monopolistically competitive
organizations is achieved when average
revenue is equal to average cost. In such
a case, organizations receive normal
profits. However, in the long run, both
the conditions (MR=MC and AR=AC)
must hold to attain equilibrium.
 4. OLIGOPOLY
Oligopoly refers to the presence of few sellers in the market selling the homogeneous or
differentiated products. In other words, the Oligopoly market structure lies between the
pure monopoly and monopolistic competition, where few sellers dominate the market and
have control over the price of the product. Under the Oligopoly market a firm either
produces homogeneous or heterogeneous products. Oligopoly is either perfect or
imperfect/differentiated. In India, some examples of an oligopolistic market are
automobiles, cement, steel, aluminium, etc.
Features of Oligopoly
1. Few firms

Under Oligopoly, there are a few large firms although the exact number of firms is
undefined. Also, there is severe competition since each firm produces a significant portion
of the total output.

2. Barriers to Entry

Under Oligopoly, a firm can earn super-normal profits in the long run as there are barriers
to entry like patents, licenses, control over crucial raw materials, etc. These barriers prevent
the entry of new firms into the industry.

3. Non-Price Competition

Firms try to avoid price competition due to the fear of price wars in Oligopoly and hence
depend on non-price methods like advertising, after sales services, warranties, etc. This
ensures that firms can influence demand and build brand recognition.

4. Interdependence

Under Oligopoly, since a few firms hold a significant share in the total output of the industry,
each firm is affected by the price and output decisions of rival firms. Therefore, there is a
lot of interdependence among firms in an oligopoly. Hence, a firm takes into account the
action and reaction of its competing firms while determining its price and output levels.

5. Nature of the Product

Under oligopoly, the products of the firms are either homogeneous or differentiated.

6. Selling Costs
Since firms try to avoid price competition and there is a huge interdependence among firms,
selling costs are highly important for competing against rival firms for a larger market share.

Price and output determination under oligopoly – Kinked Demand Curve

The kinky demand curve model was developed by Prof. Paul M. Sweezy of America to explain
price rigidity under oligopoly. The kinky demand curve represents the pattern of business
behaviour of a firm which has no incentive either to raise or to lower its price. The firm
thinks it best to adhere to the existing price unless some factors like cost compels him to
change the price.
 • In this figure AR is a kinky demand curve of a firm. Accordingly, MR has gap. MC
equalizes MR in the gap determine OP price and OQ output to be sold.
• If due to increase in cost, marginal cost curve shift upward from MC2 to MC1, it again
intersected MR within the gap resulting into no change in price or quantity. It means
entire increased cost burden falls on the seller and his total cost decreases.
• In case, cost decreases, marginal cost shifted to MC3 downward. Again MC3 intersect
MR in the discontinued gap. Price and output remains the same. The profit of the firm
will increase.
• It becomes clear that if change in cost conditions affects the MC1 within the gap of
MR, it does not bring any change in price and output.
• It is evident that price under oligopoly tends to be rigid unless drastic changes takes
place in the cost conditions or demand.

PRICING METHODS AND STRATEGIES

Price
Price denotes the exchange value of a unit of a product expressed in terms of money.
It is said that if a firm were good in setting its product price it would certainly flourish in
the market. This is because the price is such a parameter that it exerts a direct influence
on the products demand as well as on its supply, leading to firms’ turnover (sales) and
profit. If the price is set too high the seller may not find enough customers to buy his
product. On the other hand, if the price is set too low the seller may not be able to recover
his costs. There is a need for the right price further, since demand and supply conditions
are variable over time what is a right price today may not be so tomorrow hence, pricing
decision must be reviewed and reformulated from time to time.
Objectives of Pricing Policy
Objectives of a properly planned pricing policy should be logically related to overall
managerial goals. Five main objectives of pricing are:
(i) Achieving a Target Return on Investments
(ii) Price Stability
(iii) Achieving Market Share
(iv) Prevention of Competition
(v) Increased Profits
 Pricing Methods
The important pricing methods followed in practice are discussed below.
1. Sealed bid Pricing:
Sealed bid pricing is the process of offering to buy or sell products at prices nominated
in sealed bids. Companies must submit their bids by a certain time. The bids are later
reviewed all at once, and the most desirable one is chosen. Sealed bids can occur on either
the supplier or the buyer side. Via sealed bids, oil companies bid on tracts of land for
potential drilling purposes, and the highest bidder is awarded the right to drill on the land.
Similarly, consumers sometimes bid on lots to build houses. The highest bidder gets the lot.
On the supplier side, contractors often bid on different jobs and the lowest bidder is awarded
the job. The government often makes purchases based on sealed bids. Projects funded by
stimulus money were awarded based on sealed bids.
2. Marginal Cost pricing:
The practice of setting the price of a product that equal to the extra cost of producing an
extra unit of output. By this policy, a producer charges, for each product unit sold, only the
addition to total cost resulting from materials and direct labour.
Businesses often set prices close to marginal cost during periods of poor sales. The
business would choose this approach because the incremental profit from the transaction is
better than no sale at all. The Marginal Cost Pricing is useful in the short period whereas
Full Cost Pricing is mainly for the long period. As long as the marginal cost is covered there
is a sort of guarantee that the firm will not shut down.
The firm generally follows Marginal Cost Pricing when it enters into a new market; the firm
having unutilized capacity and that there is high degree of competition in the market.
3. Cost Plus Pricing:
Cost-plus pricing is the simplest pricing method. A firm calculates the cost of producing the
product and adds a percentage (profit) to that cost to give the selling price. This appears in
two forms: 1. Full cost pricing – It takes into consideration both variable and fixed costs
and adds a percentage of markup.
2. Direct cost pricing – It considers only variable costs plus a percentage of
markup. This is only used in periods of high competition as this method usually leads to a
loss in the long run.
This method, although simple, does not consider the demand for the product, and
there is no way of determining if potential customers will purchase the product at the
calculated price. Cost-plus pricing is a method used by companies to maximize their profits.
There are several varieties, but the common thread is that one first calculates the cost of
the product, then adds a proportion of it as markup. Basically, this approach sets prices that
cover the cost of production and provide enough profit margin to the firm to earn its target
rate of return. It is a way for companies to calculate how much profit they will make.
4. Going Rate Pricing:
In the going rate-pricing method, price is determined on the basis of present rates prevailing
in the market. Companies may set prices high or low depending on product/services to their
competitor's prices.
This method of pricing is useful for products/services which show fewer variations
between producers. It is also called a competitive parity method. In this method,
competitor's price is taken as base and price is set according to objectives, services offered
and product quality.
5. Penetration Pricing:
Penetration pricing is a strategy used by a firm who wishes to enter a new market and gain
a high market share through selling at a low price. The aim of penetration pricing is to
attract a loyal customer base through offering the most competitive price in the market and
undercutting rivals and well-known brands.
 Penetration pricing is also a marketing trick by setting eye-catching low prices, the
firm hopes that it will be able to gain consumer awareness of the firm’s entrance into the
market.
The drawback of penetration pricing for a firm is that in the short-term it will make a
loss or very low profit. But if penetration pricing is successful, then over time, it can slowly
start to increase prices.
6. Skimming Pricing:
Skimming is adopted where a new product is launched and the seller has little information
on the acceptable price in the market. The seller, therefore, starts by setting a high price
on the launch of the product and then, over a period of time, lowers the price to meet the
varying price elasticities of demand.
This enables gradual expansion in capacity by the seller. This practice is followed in
the consumer durables market. The seller chooses to start by setting at a high price to avoid
the risk of losing the customers who are willing to pay a high price.
7. Block Pricing:
Block Pricing is a pricing strategy where different products are combined into a single
package and sold as one unit at the block price. With Block Pricing, customers cannot
purchase the individual products included in the block separately from each other. They are
forced to purchase the entire block or nothing at all.
The objective behind block pricing is to maximize revenue per sale. Businesses
charge different prices for different products, for different quantities of products, and for
different combinations of products based on how they are bundled together.
8. Peak Load Pricing:
There are certain products and services for which demand varies by time of the day, the
week, the season or the year and supply costs also vary with the extent of demand. For
example, the demand for electricity is higher during the day than at night power being
demanded by both businesses and homes during day. Similarly toll roads or highways have
more traffic during rush office hours than at other times of the day. Airlines face heavier
travel traffic during holidays. In such cases price structures should be constructed to reflect
these conditions.
Peak load pricing is the practice of charging a higher price for a service when demand
is high and capacity is fully utilized and a lower price when demand is low and capacity is
underutilized.
The peak load pricing principle requires that the consumers who value a product or service
the most and impose the greatest demand on the production capacity should also pay more
for that capacity.
9. Cross Subsidisation Pricing:
The practice of charging different prices to different consumer groups is known as Cross-
Subsidization. When higher prices are charged to one group of consumers to charge a
subsidized lower price for another group of consumers, it is called Cross-Subsidization.
Cross-Subsidization is prevalent in sectors such as power, healthcare, telecommunication,
health insurance and higher education.
For example, cost of generation and supply of one unit of electricity is the same
irrespective of the consumers to whom the electricity is being supplied. However, each
consumer or consumer group may be charged a different tariff. Such as, domestic
consumers are charged a lower rate than industrial consumers.