Unit 4: Pricing practices & factor pricing
Managerial Economics-I notes · PTU syllabus (BBAGE 101-18)
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Unit summary
Pricing is one of the most important managerial decisions. This unit covers common pricing practices, commodity pricing, the economics of advertising costs, and factor pricing — how wages, rent, interest and profit are determined — including collective bargaining, real versus nominal interest rates and basic capital theory.
After this unit you can
- Explain cost-based and market-based pricing practices
- Discuss commodity pricing and the economics of advertising
- Explain the demand and supply of factors and collective bargaining
- Explain theories of rent, interest and profit, and real vs nominal interest
PTU syllabus topics
- Pricing practices
- commodity pricing and economics of advertisement costs
- demand and supply of factors of production
- collective bargaining
- rent
- profit and interest
- real vs. nominal interest rates
- basic capital theory
- Rent
- Reward for land
- Wages
- Reward for labour
- Interest
- Reward for capital
- Profit
- Reward for entrepreneurship and risk
- Real interest rate
- Nominal rate − inflation
Topic 1
Pricing practices
Cost-plus pricing
Average cost + fixed mark-up
Marginal cost pricing
Price covers at least marginal cost
Going-rate pricing
Match competitors' prices
Penetration pricing
Low price to win market share
Skimming pricing
High launch price for early buyers
Price discrimination
Different prices for different segments
Transfer pricing
Prices for goods traded between divisions
Example
A new smartphone launched at a high price and reduced after six months follows skimming; a new streaming service with a low introductory price follows penetration.
Topic 2
Commodity pricing and advertising costs
Commodity pricing (wheat, crude oil, metals) is largely set by demand and supply in organised markets, affected by seasons, global prices, government support prices (MSP) and speculation. Advertising (selling) costs shift the demand curve to the right and make it less elastic by building brand loyalty. Optimal advertising: spend until the extra revenue from one more rupee of advertising equals one rupee. Advertising raises costs, but can lower average cost through larger sales.
Topic 3
Factor pricing and collective bargaining
Factors of production earn factor incomes: land → rent, labour → wages, capital → interest, entrepreneurship → profit. The marginal productivity theory says a factor is paid its marginal revenue product (MRP) under perfect competition. The demand for a factor is derived demand — it depends on demand for the goods it produces. Collective bargaining is negotiation between employers and trade unions on wages and working conditions; it can raise wages above the competitive level and improve conditions.
Topic 4
Rent, interest and profit
| Factor income | Main theories |
|---|---|
| Rent | Ricardian theory: rent arises from differences in land fertility (differential rent); modern theory: rent is any surplus over transfer earnings |
| Interest | Classical theory (savings and investment); loanable funds theory; Keynes's liquidity preference theory |
| Profit | Risk-bearing theory (Hawley); uncertainty theory (Knight); innovation theory (Schumpeter) |
Real vs nominal interest: the nominal rate is the stated rate; the real rate adjusts for inflation: real rate ≈ nominal rate − inflation rate (Fisher equation).
Example
A deposit pays 7% while inflation is 5%: the real return is about 2%.
Basic capital theory: capital is produced means of production; its value is the present value of the future income it generates, so investment depends on comparing expected returns with the interest rate.
Key terms
- Cost-plus pricing
- Price = average cost + mark-up
- Penetration pricing
- Low initial price to gain market share
- Derived demand
- Demand for a factor arising from demand for its product
- Collective bargaining
- Negotiation between employers and unions
- Real interest rate
- Nominal rate adjusted for inflation
Quick revision
- Skimming high then lower; penetration low to grow share.
- Advertising shifts demand right and makes it less elastic.
- Factor incomes: rent, wages, interest, profit.
- Real rate ≈ nominal − inflation.
- Profit theories: risk, uncertainty, innovation.
Important exam questions
Practice questions written to the PTU exam pattern for this unit's syllabus: short answers (Section A style) and long answers (Sections B and C style).
Short-answer questions
- Q1.What is cost-plus pricing?
- Q2.Differentiate between skimming and penetration pricing.
- Q3.What is derived demand?
- Q4.What is collective bargaining?
- Q5.Differentiate between real and nominal interest rates.
- Q6.State Schumpeter's innovation theory of profit.
Long-answer questions
- Q1.Explain the various pricing practices followed by firms.
- Q2.Explain the marginal productivity theory of factor pricing and collective bargaining.
- Q3.Explain the theories of rent, interest and profit.
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