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Average Cost Pricing

  Average Cost Pricing

    Nevertheless, for non-profit organisation, average cost pricing is extensively used doctrine. In this doctrine, government does not offer grant to hold the organisation continuing.

    In this strategy, rate is determined at the level paritying to AC. Nevertheless, in this average cost the fair return on capital is incorporated. The fair return on capital is cost of capital.

    In the below diagram 2, average cost curve AC integrates fair return on capital. Let us assume the below diagram where AR curve is cutting AC curve at point S. As per it, under average cost pricing does not aim at optimising profit V2 is manufactured.

    Though average cost pricing doctrine does not goal at optimising profits and in its place it only assures fair or usual return on capital, full economic efficacy in resource distribution is not accomplished under it.

    It is to be noted from the below diagram 2, that productivity under average cost pricing doctrine is lower and rate larger than under marginal cost doctrine.

     Thus, average cost, pricing doctrine is regarded as second best rate strategy hence marginal cost pricing strategy; though it makes sure optimum economic efficacy needs subsidy which due to financial restraint regime is frequently not able to pay.

     Nevertheless, there is a significant censure of average cost pricing strategy, usually organisations with makes sure of fair return on capital inflate their costs by paying huge salaries to their workers or by paying huge perquisites to their marginal staff.

     This is for the reason that whatever their cost they will add fair return on capital to determine the price of their commodity or service. They will still claim to be working on no-profit doctrine.

    In such crate, prices are hiked at higher level which creates a lot of economic inefficacy in resource distribution. Apart from it, average cost doctrine becomes a tool in the hands of organisation which seek to cover up their operational inefficacy by declaring higher average cost of manufacturing so as to set price at a huger level.

     The burden of this is tolerated by the consumers who get the commodities or services at a larger price though organisations claim to be working on profit basis.

     In-fact this is the case in a developing nation whereas public organisation such as railways, postal department have been hiking passenger rates, freight rates and postal charges on the pretext of rise in average cost of manufacturing which is in-fact due to their gross operational inefficacies.

  1. Ramsey Pricing

     Ramsey pricing strategy has been advised in the context of regulating multi-product monopoly industry or public utility companies such as electric supply company, gas company, railways which have to sell their commodity in two markets or more, or to two or more categories of customers or users.

     The difficulty countenanced by the organisation functioning in these areas is how to distribute common costs incurred on the provision of commodities to various commodities or their diverse purchasers in determining prices of commodities and services.

     For instance, electric supply company has to incur a lot of expenses on high voltage transmission lines through which electricity is transmitted to residential consumers for hosiery needs as well as to the commercial and industrial consumers.

     The difficulty is how to distribute among diverse types of consumers huge outlay incurred on high voltage transmission lines which are common to all types of consumers.

      The problem mounts for the reason that common costs by definition cannot be assigned to any definite commodity or service. Inspite of these difficulties many industries widely utilise fully allocated cost strategy.

     They make a decision in a random mode the allocation of common costs to diverse commodities or services or diverse categories of customers. The price determined in this method, wraps the definite part of common costs in addition to costs that are directly associated to the provision of definite commodity or service.

       Ramsey advised that though an industry must recover its common costs fully but it is not needed that the price of every commodity set at a level huge enough to wrap a randomly distributed share of common costs.

     This is for the reason that such a random strategy of distributing common costs wills consequent in huge economic inefficacy in resource distribution and resultant loss of social wellbeing.

     Nevertheless, marginal costs do not cover predetermined common costs as they represent addition to direct costs incurred on offering an additional unit of commodity or service. Note that multiplying cost is entirely supplementary cost which would not be incurred if the commodity or service is not manufactured.

      So long as the revenue from a commodity surpasses its additional cost, the industry will be enhancing its profits by supplying the commodity or service. Ramsey pricing doctrine offers second best pricing scheme that enables the organisation to atleast break even while creating minimum failure to economic efficacy in resource distribution.

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