Analysis of a Firm's Pricing Strategy
A company's production and pricing data for its flagship product over a three-year period is provided in the case study below. Analyze this data to determine if the company's pricing strategy is consistent with an economic model that assumes firms maintain a constant profit-maximizing markup over their costs. Justify your conclusion by showing the calculated markup for each year.
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A company operates in an industry where, for modeling purposes, it is assumed that the intensity of competition does not change as firms alter their output. This company experiences a 10% increase in its marginal cost of production. Based on the pricing rule that assumes a constant profit-maximizing markup, how will the company most likely adjust its selling price?
In an economic model where a firm's pricing power relative to its competitors is assumed to be stable and unaffected by its output level, the profit-maximizing price will be a constant multiple of the firm's marginal cost (e.g., the price might always be 1.5 times the marginal cost).
Underlying Assumptions of Constant Markup Pricing
Analysis of a Firm's Pricing Strategy
Price as a Markup Over Marginal Cost
Price Markup as a Constant (μ)
A firm operating in a market with very few competitors and selling a product with no close substitutes will likely set its price with a small markup over its marginal cost.
Assumption: Labor as the Sole Production Cost