Thursday, May 17, 2012

Cost and Market pricing - A Light-Hearted Way of Explaining

This is a true story – the key characters are none other than my boys and yours truly. 

Below is a simplified version of what I have read a few months ago about cost and market pricing. 

Price Effects The most common argument about cost pricing is that with higher prices, firms will pass on to consumers in the form of higher prices. And conversely, lower cost price will mean lower selling price. However, this argument is not entirely correct in that firms will charge the prices that maximise their profits. These prices will be the maximum prices that the market can bear. Let us apply this on a more familiar example – housing prices. The price of new housing is no lower when the developer had the good fortune to obtain the land below its current market value (e.g. because it was bought before planning permission was available) than when the developer has paid the full market value. In either case, the price is determined by the housing market at the time the new housing is sold. 

This is how I explain to my primary 5 boy P about cost and market pricing, using his little brother R’s exploit: 

R looked around for his classmates who were willing to pay $1 for a green bean. He then asked around for other classmates to buy some green beans. He bought 5 green beans at $0.50. Thereafter, he sold one to his friend at $1 a bean. He kept the balance four for his science project. 

Question: Does R’s cost price of 5 green beans at $0.50 have any bearing on his selling price of $1 for 1 green bean? 

P’s answer: No. 

Mummy’s further comment: That’s right, R will sell based on what the market – his classmates -  is willing to pay and not the cost price. That is market pricing.

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