The price for a product is one of the more important decisions a company makes. An increase in price may cause total sales to drop, affecting the number of items a company needs to produce. A price decrease may cause total sales to increase. The flexible budgets from the previous lesson showed you how changes in sales price affect the variable costs for a company. This lesson will address how a company approaches setting prices when it is a price-taker or a price-setter.
A price-taker is a company that cannot affect the market price of its product. Normally, the product is not unique, and there is a lot of competition. A consumer would have many options when looking for such products as copy paper, eggs, or gasoline, so a company that produces these products will use target pricing to determine the market price for its product and then attempt to reduce expenses to reach its target profit.
A price-maker is a company that can set its product price because the product is unique and/or has little competition. A pharmaceutical company that has developed a new drug can set the price that it will charge, sometimes with little or no competition. A company that produces products like this will use cost-plus pricing, in which it calculates the cost of the product and then adds enough of a markup to cover all costs and reach its target profit.