Market Pricing and Marginal-Cost Pricing

Market Pricing

Market pricing is where the only sensible price to charge is what the customers perceive the product to be worth. Obvious examples are things sold by auction — in the art market, for instance. The price is what the highest bidder is 'prepared to go to'. Similar conditions apply to a large degree in the used housing market, where the vendors can ask whatever price they like but ultimately depend on negotiating the best price a buyer is willing to pay. An important consideration in many situations, however, is the buyers' perception of the product they are being offered. When the products are unique and/or appeal to a select group of people, this can be the overriding consideration.

Marginal-Cost Pricing

In a highly competitive situation companies may have the opportunity to gain business if they can offer a sufficiently low price. This is especially the case where individual contracts are negotiated such as large construction projects but is also increasingly evident in markets such as electrical appliances, where electricity boards, discount houses and other large retail chains are often in a position to 'shop around' for the best bulk discounts.
The question may then arise, 'What is the lowest level at which it makes sense to take the business?' One approach to this is to carry out a marginal costing calculation. In economics, marginal cost is the cost of producing one more unit. Usually in practice this means that fixed costs are already being recovered by a sufficient level of sales of units priced. The cost of producing extra units then affects the variable costs only, so that even if a very small profit per unit can be added, the business is worth taking.
We can go on from there and argue that even at no profit the business would be worth taking, because it may use resources (including people) that would otherwise stand idle. The danger here is that success in selling at these price levels may lead to additional orders and perhaps the business actually eats into existing profits.