Full Costing and Pricing Decisions
Posted: 15 Mar 1998
Date Written: December 1997
Using theoretical analysis and simulation experiments, we examine the usefulness of full costs for product pricing. We show that full costs are economically sufficient for pricing when a decision-maker (DM) jointly solves the capacity planning and pricing problems, and has enough discretion in setting prices to ensure full capacity utilization in any demand state (the full capacity utilization condition). In practice, however, informational limitations and cognitive bounds may induce the DM to plan capacity using limited demand information, and update prices when additional demand information becomes available subsequently. There is no economic loss from such problem decomposition if the full capacity utilization condition holds. We use simulation experiments to assess the loss from this decomposition if this condition is not satisfied. We find that using simple full cost plus pricing as an input into capacity planning is cost effective provided the DM reacts optimally to realized market conditions, and has enough pricing discretion to ensure high capacity utilization.
JEL Classification: M40, M46, D40
Suggested Citation: Suggested Citation