Many firms use a technique called target pricing in trying to decide what prices

Question

Many firms use a technique called target pricing in trying to decide what prices to set for new products they are introducing. The target price is a price that enables the firm to recover a certain percentage of the product’s development and production costs. What, in addition to costs, must the seller know in order to calculate the return a particular price will yield? If earnings from the sale of the product turn out to fall short of the target, should the firm raise the price? If earnings exceed the firm’s expectations, should it lower the price?

Explanation / Answer

Target price = Expected costs + Pre-determined mark-up on cost

So, in addition to costs, the firm must know precisely what percentage of total costs the firm wants to earn as a mark-up, to arrive at the target price.

If actual earnings differ from expected earnings, whether to raise price or lower price will depend on the price elasticity of demand in the target market. If demand is inelastic in target market, a price rise will increase revenue and so the firm can raise price if actual earnings are lower than expected earnings, or firm can lower price if actual earnings exceeds expected earnings. Revenue will increase in both cases. But if demand is elastic, a price rise will decrease revenue and so the firm can lower price if actual earnings are lower than expected earnings, or firm can raise price if actual earnings exceeds expected earnings. Revenue will increase in both cases.

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