Full Cost Pricing and the Illusion of Satisficing

Posted: 18 Aug 1998

See all articles by Eric W. Noreen

Eric W. Noreen

University of Washington

David Burgstahler

University of Washington

Abstract

Most large manufacturing companies report setting prices by marking up some version of full cost. The rationale is that full cost pricing provides a "satisfactory profit." This paper shows that a full cost markup rule imposes a constraint which may prevent the company from achieving satisfactory profits even when satisfactory profits are feasible. We demonstrate that for any given cost structure and allocation basis, there always exist well-behaved demand curves such that satisfactory profits cannot be realized using a full cost pricing strategy even though satisfactory profits could be realized with a better pricing strategy. Thus, there is no guarantee that setting prices via a full cost pricing strategy will yield a satisfactory profit even in an intrinsically profitable company. In general, the more critical a pricing decision is, the less likely that a full cost pricing rule will be satisfactory.

JEL Classification: D40

Suggested Citation

Noreen, Eric W. and Burgstahler, David C., Full Cost Pricing and the Illusion of Satisficing. Available at SSRN: https://ssrn.com/abstract=106328

Eric W. Noreen (Contact Author)

University of Washington ( email )

231 Mackenzie Hall
Seattle, WA 98195
United States
206-543-4869 (Phone)
206-685-9392 (Fax)

David C. Burgstahler

University of Washington ( email )

555 Paccar Hall, Box 353226
Seattle, WA 98195-3226
United States
206-543-6316 (Phone)
206-685-9392 (Fax)

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