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Pricing Part 1

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  3. Dear John,

    In the lecture you said ‘full cost plus’ pricing has the advantage to guarantee the profitability. However, full costing method dose not address the importance of contribution. I would say without the guarantee of contribution, the profitability cannot be guarantee also. Should I assume full cost plus pricing cannot guarantee the profitability?

    Thanks!

    • Full cost pricing doesn’t guarantee overall profitability because the actual sales may be different that budgeted.

      However, the earlier part of what you have written is not true. If a profit were guaranteed then automatically contribution would be guaranteed – contribution is profit plus fixed overheads. (But the other way round is not true – making a total contribution does not guarantee a profit, because of fixed overheads).

      There are problems with both approaches, mainly stemming from the fact that both ignore the affect of the selling price on the demand. Theoretically the best way of dealing with it is dealt with in the next lecture.

  4. How is it u say maximum profit occurs when MR=MC, but in the example u did, optimum selling price is $15, MR IS 1,400 while MC is 1,360. They aren’t equal in anyway. Kindly shed more light(I think this is what fahim also meant to ask). Thanks.

    • You need to listen to the lecture more slowly. I say that when MR>MC then it is worth reducing the selling price because profit will increase. When MR<MC then it is not worth reducing because profit will fall.
      The maximum would occur when MR=MC which will be somewhere between 15 & 16, but in this question (when it is given as a table) then somewhere between 15 & 16 is not allowed, so the maximum is at 15.
      It seems that you have only watched part 1 of the lecture. If you watch part 2 then I draw a graph which might make it clearer for you.

      (and it is not at all what fahim was asking! 馃檪 )

  8. @ John Moffat

    Hi Sir, Firstly I will like to thank you and OT for these lovely lectures.Most days I work 13hrs a day and can only do studies after so going to classes is not an option so this is really a blessing for me. That said, I am using the BPP text book and I see they have a lengthly explaintion for “the profit-maximising price/output level” is this the same as the Optimal pricing method explained in this lecture. Forgive me if its a silly question but I would like to clarify this because I am not seeing the “Optimal Pricing” in the BPP text. Thank you kindly and do keep up the great work.:) Greatly appreciated.

  9. It is relevant costing, which is part of Chapter 9 of the Course Notes.

    Please realise that the Course Notes are not meant to be Study Texts – they are notes used with the lectures.
    The Course notes together with the lectures (and the Revision Lectures) cover more than enough to pass the exam well, provided that you also practice lots of past questions (preferably using an Exam/Revision Kit from one of the approved publishers).

  10. In your lecture note shows optimal pricing – tabular approach but in BPP textbook the approach is not mentioned, can you tell me why we must know that? Is that this shows in past exam question? Can you tell me which year this approach uses?

    • The reason you should know it is that both the tabular and the algebraic methods are specifically included in the Paper F5 syllabus!!

      If the BPP Study Text does not include it then I am surprised – the Kaplan Study Text certainly includes it.

      The tabular method if certainly much less likely for the exam than the algebraic method, but (as I say in my free lecture) it is important not only because it is in the syllabus, but also because understanding it explains the logic behind the algebraic method and you could be asked to explain. 50% of the exam is writing and proving that you understand the techniques involved.

      • One more question sir,

        Where is “Pricing/Decisions to increase production and sales”- ( item B4(e) in F5 Study guide Syllabus: Evaluate a decision to increase production and sales levels, considering incremental costs, incremental revenues and other factors) showing up in your Lecture Note? I cant find where it is.

        Im sorry if my question is silly but I just want to be guaranteed that your lecture note fully cover every knowledge in F5.

        Thank you.

  11. Hi Mr Moffat. Grand lecture as usual, thankyou.
    A question if I may.
    If we ignored the incremental drops to 15.5 and 15.0 and went straight from 16.0 to 14.5, marginal revenue ($4200) would then be higher than marginal cost ($4080). You could take 15.5 and 15.0 out of the equation altogether, the rest of the variables would be the same and a drop to 14.5 would appear to be justified using the optimal pricing approach.
    If you took out the variables when S.P. pu is 14.5, at an S.P. pu of 14.0, the drop from 16.0 pu would show both marginal revenue and marginal cost at $5400.
    What am I missing?

    • Hi, and thank you for the compliment 馃檪

      In anser to your question, think about the graph that I draw on the screen – the profit goes up initially and then it starts going down. We want maximum profit.

      If I said to you which is better, a profit of 20 or a profit of 30, then obviously 30 is better.
      However if I then said to you than in between the two you could make a profit of 40, then what would you say then?

      馃檪

      • Thank you for taking the time to reply.
        What you’ve written makes sense, the point at which profit is at a maximum is clear based on the variables provided.
        I’ve revisited my workings and, although the sums appear to work when you apply the workings over a range of variables, e.g. 16.0 straight drop to 14.0 as opposed to 16.0 to 15.5 etc, I suspect that I’m overthinking it and comparing apples to oranges.
        Is it fair to say that the tabular approach only gives the ‘correct’ answer when all variables are treat as individuals (per SP) and not as an accumulation or over a range?
        Thanks again

      • You are correct in saying that the tabular approach only gives the correct answer when dealing with specific prices – not over a range.
        In the past both tabular and equation approaches have been examiner (separately – not together) with equations being the more common of the two. However it will be made very clear which approach is wanted.

  12. I am not sure if I missed something, but when trying to find marginal revenue and marginal cost, you asked that we pretend that we didn’t know what total profit would be. Well then I started thinking that fixing the selling price at 15.50 would be the better option since marginal revenue of 1,500 exceeds marginal cost 1,380 by 120. When the selling price is fixed at 15, marginal revenue of 1,400 exceeds marginal cost of 1,360 by only 40. So what point did I fail to grasp?

    • If marginal revenue is higher than marginal cost, the the difference is extra profit.

      If you get 40 extra profit then it is worth dropping the selling price. (Even if it was just $2 extra then it would be worth it)

  13. Sir, I’m sorry but I didn’t understand the part where you said Maximum profit occurs when Marginal Revenue= Marginal Cost. If they are the same then we can’t be making profits? I’m a bit confused….

  14. Dear John,
    I note your every lecture on my pc. But can you let me know which writing tablet and stylus(pen) you use to write on the screen? so I can write easily. The current one that I have is awful. Which software you use to record the screen??

    Btw I am big fan of yours lectures 馃檪

    Many Thanks

  15. There is a small description of opportunity cost plus in the notes, but it was nowhere to be found in the lecture. Sir can you please give a detailed explanation of what it is, accompanied with an example and its relevance in exams?

      • The idea is very simple. Suppose you are going to produce a new product and are trying to decide on a selling price.
        The materials used are in short supply and currently they are all used making another product which generates a contribution of $5 per unit.
        Each unit of the new product will use 2 kg of material, whereas the existing product uses 1 kg of material per unit.

        If we make the new product then every unit produced will mean that we are unable to produce 2 units of the existing product (because of the short supply of material).
        Since the existing is generating $5 per unit and we will lost 2 units, each unit of the new product will have to generate $10 per unit.

        Therefore the selling price will have to be at least the cost of production plus $10 for it to be worth producing.

        (The extra $10 is an opportunity cost – we are not actually spending $10 but we would be losing $10 elsewhere.)

        The idea is more relevant for other topics – for example in transfer pricing – and it is dealt with in more detail with examples in those chapters and lectures.

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