Evaluation of Different Pricing Strategies
The models are based on the average cost approach to price setting but differ slightly In detail.The paper Initially examines the models from an analytical point of view.The paper then describes a simulation model used to evaluate the effect of both decision approaches over time.
While the models are analytically similar the simulation results show that the long run behavior of the firm is significantly different under each approach. This work is part of the author’s PhD research and represents ongoing rather than completed work. Please do not quote without prior permission. Introduction
This paper continues the author’s examination of firm growth using analytical and simulation modeling methods and which has already been discussed in Brady (1999; AAA, b and c; 2001). This paper specifically examines firm growth under two different managerial policies both of which use the average cost including demand pricing assumption discussed in Brady (2001). Methodology Two models identical in all respects but one were used in this research. Both models used the average cost including demand approach IEEE. Firms produce product at a certain cost and then set out to sell that product at a marked up price.
The models defer in the policy adopted by the firm when production exceeds demand for their product. The firm in model A sells whatever quantity it can at Its marked up price as documented In Brady (2001). The firm In model B sells the quantity It produces at the price the market will bear [e. It sells at the price determined by the firm’s demand curve. Model A Is more realistic In that firms Immediately realism that they have exceeded their demand curve In that they are unable to sell product at the marked up price and either they Increase Inventory or goods perish.
Model B Is less realistic In that firm’s cannot determine price with certainty from the demand curve (they do not know their demand curve with certainty): in practice firms must determine this price by some kind of atonement mechanism. Note Tanat tons osculation does not model ten atonement process itself; instead it determines the new price directly from the demand curve. In summary, when production exceeds demand, under model A the firm sells less product than it anticipates but holds its price whereas under model B the firm sells all it produces but at a lower price.
Specifically model B differs from model A as follows: the demand function (P = a – BC) used is the inverse function to that used in model A (Q = a – BP); these two expressions are functionally equivalent. The models also differ in that in model A units sold were equal to the units produced or units demanded, whichever is the lower; in model B the price at which goods are sold is equal to the marked up price or the demand price (e. The price given by the demand function), whichever is the lower. In all other respects, including the values of all parameters, the models are identical.
In the case of both models demand is held constant throughout the simulation ‘e. The demand curve does not shift upwards or downwards during the simulation. Also, depreciation has been set to zero during the simulation and fixed costs remain constant throughout the simulation (IEEE. There is no step increase in fixed costs as described in Brady, 2001). Results The results of the simulation for model A are shown in figures 1, 2, 3 and 4. Examining firstly firm size, as measured by capital, we see in figure 1 that the firm increases in size until approximately period 50 and then firm size remains more or sees constant.
To see why this is so we examine firm retained earnings as shown in figure 2. Here we see retained earnings increase monotonically until period 42 and then decrease asymptotically to zero. Figure 3 shows both revenue and total cost and clearly demonstrates this decline in margin. Here we see the firm maintaining its margin percentage until period 42; margin then declines dramatically until approximately period 60; margin continues declining asymptotically to zero. 01 2 0 1 Capital Accumulated_loss 125021002 Time Figure 1. Model A: Capital Retained_earnings 0050100 Figure 2.
Model A: retained earnings This decline in earnings is due to the fact that production exceeded demand in period 42 as shown in figure 4. From that period onwards the firm incurred an increasing cost of overproduction and gradually its margin eroded completely. Although the change in period 42 is abrupt the firm comes smoothly to an equilibrium state (although unfortunately for the firm this equilibrium state is one of zero profitability). On the positive side, the firm never makes a loss as it stops increasing production at a point before its price drops below cost.