Managerial economics

The price that is set for the sale of a product will help determine the number of sales that are achieved as well as the potential level of revenue and level of profit. A range of pricing theories exist, but as time goes by and a product is on the market the different influences may change and the goals of the organization may also change. If we consider the case of a fast food chain, such as Burger King, the company, or a franchise, may need to increase sales and increase revenue. If sales have been falling and there is the desire to increase the sales and the lost profit the company may consider changing the price of the goods they sell, or changing the price of one key product as this may also influence other sales.

For example, if the company can sell more burgers they are also likely to increase the sales of the complimentary items, such as the fries and the rinks. In this case we will assume there has been a fall in sales and Burger King was to increase sales and increase their overall revenue and profit. The alteration of prices may be seen as an opportunity to increase revenue.

We will assume that the company is considering decreasing the process of the burgers in order to get more people into the restaurants. They hope that by increasing the level of sales they can increase the profit with less made on each individual sale, but making up for the lower profit per unit with a larger number of units sold. Hey also want to increase the sale of other items and try and create a habit and loyalty in the customers coming into the branch so that there are long term benefits.

The first consideration needs to be that of price elasticity. Generally speaking as the price for a good falls the demand will increase, as the price for a good increase the demand will fall. For a burger chain there is an advantage as the preparation of the food can be matched to the demand at any time of day and it is unlikely that maximum capacity will ever be reached and as such the supply chain is flexible and can be managed to cope with the different level of demand (Wheatley, 2005)

To make the decision the first consideration is at what levels price changes will be feasible. For this we need to look at price elasticity. The amount of goods demands in line with a price change will vary. If the price falls then the demand will increase, it is whether the demand increases in line with the price drop that is important. The level to which the demand will change in line with price changes is known as price elasticity.

In most cases an increase in price will result in a decrease in demand and a decrease will result in an increase in demand, this can be calculated with the use of previous figures from the shops. This calculation allows us to quantify the change. The calculation is in the form of a division, on the top of the division is the percentage change in the quantity demanded, (this means the percentage change in the number bought if these are form historical figures), which is then divided by the bottom of the division equation, this is the percentage change in the price of the product.

An example of this may be if there is a demand drop in the product of 50% and there has been a percentage increase of 50% the equation will be -50/50 leaving use with an answer of -1. The result will usually be a negative figure; however, the negative sign at the front is only omitted. The result of one means that for every 1% increase in price there will be a 1% decrease in the demand (Nellis and Parker, 2000). For essential goods the drop in demand is likely to be less that the increase in price, this is seen with goods such as utilities or addictive goods such as tobacco or drugs and these are seen as being inelastic. Where the decrease in demand is the same proportion or greater than the increase the goods are elastic (Shrestha and. Marpaung, 2005). Luxury good such as holiday and designer clothes are elastic (Montgomery and Rossi, 1999). Burgers are not essential, and if there are many other fast food chains nearby giving increased choice to the consumer the level of elasticity is likely to be higher. Where the rate is 1 then the rate of change in demand is proportional. If we assume that the rage is 1.5 then for every 1% drop in price there will be a 1.5% increase in demand and as such a lower price will result in higher sales ands also higher revenue. If the elasticity was .75 then the decrease of 1% in price would increase the demand by only .75% and as such there would be an overall fall in revenue.

Demand is influenced by price, but there are also many other influences that will impact ion demand. The influences may include the availability and acceptability of substitutes. For example, if there are many substitutes available then price increases may have reduced sales disproportionately as customers moved over to the substitutes (Stiroh, 1999), for example going to another fast food restaurant. The Burger King burgers could be seen as a substitute for these goods as well as seek to attract the customers of the other chains with aggressive marketing (Sethuraman et al, 2005). The role of marketing is also an influence, increased awareness and marketing that makes a product look attractive can increase the demand regardless of the price level. This can also interact with the substitutes and increase demand from this area. The cost of complimentary good may also have an impact, where complimentary goods are low in price they may help increase demand, in this case we are using the burgers as a complimentary good to the other menu items, which if the demand for burgers increase will also see an increase with no need to change the prices.

There are risks with this type of strategy, using a low pricing strategy can create a price war with other, often more powerful companies, also cutting process and reducing the level of profits that are seen. Cut prices may also send a message of lower value to the consumer who may be put off due to the idea of lower quality (Kotler, 2003). Low prices may also be used when seeking to gain market entry, to get the product known. But, this can be a difficult policy as increased sales with a very low price are unlikely to lead to a fast return of investment and profits may take a long time to emerge while other companies have time to try and reverse engineer a product. This is seen in high tech industries. However where an entrepreneur has a unique product they may also decide to place a high price on it as there is no direct competition or substitute. If the product is marketed at early adopters this is a market where there is less sensitivity to price and as such it is the concept and attraction of the product that matters. The sales will be lower but the overall profit can be much higher and with early introduction this also allows for a more stable growth in the manufacture. However, this may also result in difficult gaining the first mover advantage. The usual strategy is to drop the price as manufacture levels increase and sales increase after the investment has been recouped.

To decide what strategy to follow the company needs to gather a large level of data. Some of this will be the past movements between the demand and the products price, However, as seen this is not a simple calculation, as other influences at the time will also need to be considered, such as the amount that was spent ion advertising and the cost of the competing, substitute and complimentary products, not only in the company, but in the environment as a whole. Other less visible influences may also need to be measured, such as the economic climate, for example, where there are low interest rates and low taxes disposable income is higher then when interest rates are high. Where there is more disposable income consumers are more prepared to spend it on non essential goods. These figures can be gained from the Federal Reserve and government statistics. When it comes to the collection of data regarding the competition then the use of the employees and competitive intelligence is valuable, looking at the trade press, the media and the way they are currently running promotions. The use of game theory may also come into play. Overall, it is likely, that if the economic climate is stable, and the price of the burgers is dropped short term sales may increase for the burgers and the complimentary items, but, it is also likely that the competition will try to compete and the benefits may not be long term, necessitating strategy changes in the future ands showing why pricing strategy alone is not sufficient for long term business goals to be sustained and competitive advantages are needed (Thompson, 2005). However, pricing strategies and the use of prices can be n effective tool when used as part of a larger strategy.


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