Basic Marketing: A Global Managerial Approach

Perreault−McCarthy: Basic

Marketing: A

Global−Managerial

Approach, 14/e

18. Price Setting in the
    Business World

Text © The McGraw−Hill

Companies, 2002

530 Chapter 18

The implication of this is important. Marginal analysis seeks to identify the best

price, the price that maximizes profits. This is perhaps an ideal rather than what is

usually achieved in practice. After all, few managers know the exact shape of the

demand curve. However, the range of profit around the ideal price means that the

price and quantity estimates don’t have to be exact to be useful. They still help us

get close to the ideal price even if we don’t hit it exactly.

In a weak market, demand may fall off and there may be no way to operate at a

profit. If this is a permanent situation—as might occur in the decline stage of the

product life cycle—there may be no choice other than to go out of business or do

something totally different. However, if it appears that the situation is temporary,

it may be best to sell at a low price, even if it’s not profitable.

Why would you sell at a price that is unprofitable? Marginal analysis provides the

answer. Most fixed costs will continue even if the firm doesn’t sell anything. So if

the firm can charge a price that at least recovers the marginal cost of the last unit

(or more generally, the variable cost of the units being considered), the extra income

would help pay the fixed costs and reduce the firm’s losses.

In Chapter 17 we noted that marketing managers who compete in oligopoly sit-

uations often just set a price that meets what competitors charge. Marginal analysis

also helps to explain why they do this.

Exhibit 18-11 shows a demand curve and marginal revenue curve typical of what a

marketing manager in an oligopoly situation faces. The demand curve is kinked, and

the current market price is at the kink. The dashed part of the marginal revenue

line in Exhibit 18-11 shows that marginal revenue drops sharply at the kinked point.

Even if costs change somewhat, the marginal revenue curve drops so fast that the

marginal cost curve is still likely to cross the marginal revenue curve (that is, mar-

ginal cost will be equal to marginal revenue) someplace along the drop in the

marginal revenue curve. In other words, marginal costs and marginal revenue will

continue to be equal to each other at a price and quantity combination that is close

to where the kink occurs already. So even though the change in costs seems to be

a reason for changing the price, prices are relatively “sticky” at the kinked point.

Setting the price at the level of the kink maximizes profit.

800

700

600

500

400

300

200

100

0

–100

–200

–300

–400

Quantity

Total profit

Total

revenue

Total cost

Best profit

for quantity

at best price

=

=

=

$106

6

Dollars $79

246 8

Exhibit 18-10
Graphic Determination of the
Price Giving the Greatest
Total Profit for a Firm

How to lose less,
if you must

(^0) Quantity
D
MR
Price ($)
Market price
Exhibit 18-11
Marginal Revenue Drops
Fast in an Oligopoly
Marginal analysis
applies in oligopoly too