Pricing of Food Products

APEC 4451 / 5451

University of Minnesota

WHAT GOES INTO SETTING A PRICE? Profit, Sales volume, Ethics, Laws, Cost, Promotions,

Price discrimination

First, Second, and Third Order Price discrimination

Charging different prices to different consumersfor the same product

First order: Extract all consumer surplus with multiple prices

Second order: charge different prices for different blocks of sales

Third order: Different consumer demand elasticity in different markets - charge each a different price equating MC to MR in each market.

University of Minnesota

Buyers “valuation” of the product/service

Price

P

Q

revenue

value

Consumer surplus

First order price discrimination

Second Degree Price Discrimination

Third Order Price Discrimination

Coca-Cola Vending Pricing

• Price by the temperature ???

• Why not??

Price elasticity

University of Minnesota

Price elasticity%change in Q / a % change in P

The slope of the demand curve

Shifts in demand vs. changes in demand

P

Po

Qo

What makes it shift?

• Consumers have an elasticity of demand => price down and quantity up (even for food)

• Economic theory (Utility Maximization) & consumer psychology/behavior => get the most Quantity for the price!

Pricing Strategy

University of Minnesota

I will raise my price to increase my revenue

When will this work? (Necessities, addictive, status, Low % of income, tourist)

% increase in price is 10 and % decrease in volume is 5 e = ??

-5/10 = -.5 => inelastic and revenue will increase

Pricing Strategy

University of Minnesota

Price elasticitye = %change in Q / % change in P

P

Q

Po

Qo

P1

Q1Q1”

Elastic demand: e >1(absolute value)Revenue loss from p increase

Inelastic demand: e <1Revenue gain from p increase

Pricing Strategy

University of Minnesota

I will cut my price and make it up on volume!

When will this work?

% decrease in price is 10% and increase in volume is 20% e = ??

20/-10 = -2 => elastic and revenue will increase

Pricing Strategy

University of Minnesota

Price elasticitye = %change in Q/ % change in P

P

Q

Po

Qo Q2 Q3

Q2= less elastic response

Q3 = more elastic response:Gain more revenue with lower priceP1

Pricing Strategy

University of Minnesota

PromotionLoyalty

Premium Quality

P

Q

more elasticless elasticPrice has less effecton quantity sold.

INCOME EALSTICITY

• Engle’s Law:

As income goes up, the portion of the increase that is spent

on necessities (food) decreases.

Income elasticity: % change in quantity / % change in income

Expenditure elasticity: % change in expenditure on a given food/ % change in income

University of Minnesota

Substitutes and complements:Cross price elasticity:1. % change in quantity of hot dog buns/

% change in price hot dogse is - => complement

2. % change in quantity of bratwurst/ % change in price of hot dogs

e is + => substitute

University of Minnesota

How do we measure profit?

Profit on sales: Revenue - Total cost = Profit

TC = marketing costs+ manuf. Costs + Overhead Costs (2variable + 1fixed)

At retail: COGS not a hard number

Rebates, promotion dollars, slotting fees etc. Questions of where these show up in profits?

University of Minnesota

COGS = $500,000 •Promotion $ from manuf. 5% = $25,000•Rebate based on volume 3% on quantity over 100 cases a week ( sell 200 cases: 100x$25/case = $2500x.03=$75) •Slotting fee if new product: $100,000

•If it is accounted for as a decrease in COGS: •$500,000 – 25,000 -75 -100,000 = $374,925

Label1

University of Minnesota

If it is accounted for as a decrease in COGS: •$500,000 – 25,000 -75 -100,000 = $374,925

#1 Revenue: $1,000,000 - COGS: $500,000 = $500,000 Gross Profit–other costs $400,000 = $100,000 Net Profit

#2 $1,000,000 - $374,925 = $625,075=> more Gross Profit (lower COGS) $625,075 – $400,000 = $225,075 = Net ProfitBUT: tradendollaresnhave to appear somewhere. If add to #1 as revenue,get same net profit as $225,075.

Issue of timing: book promotion $ before received.