Pricing Part2

ACCA F5 - Performance Management 

In the table we assume that variable production costs are proportionate to increase in quantity. But in real the learning curve, increased performance of labor, volume discount, less material wastage, reduced overhead in production pulls variable cost down as production increases to certain level before costs bumps back.

We know that cost function is Y = a + b X. This in the above table is replaced by D = B + C.

If we ignore learning effect then variable cost per unit for most of output level is equal to marginal cost per unit. This can be shown by following function:

At production level X, we have Y = a + b X    …………….1

At production level X+1, we have Y = a + b (X+1)                               OR, Y = a + b X +b

Subtracting 2 from 1, we get marginal cost MC = VC (variable cost per unit)…………………..2

Cost equations for volume based discounts:

The cost equation for above table is Y = 100 + 100 X, but if supplier offered 10% discount on total purchase/cost of material over 5units of production then we need to revise the production equation. The variable cost per unit for 6unit and higher will be 90 and revised cost equation will be Y = 100 + 90 X.

for production equal or less than 5 units	Y = 100 + 100 X
for production above 5 units	Y = 100 + 90 X

Volume discount increases profit and creates enough space for revise pricing decision. However, if fixed cost input is required with increased production we need to revise contribution for increased sales to cover increased fixed cost before making production decision.