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Accounting 1 a Solution Man

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Appendix A
Pricing Products and Services

Solutions to Questions

A-1 In cost-plus pricing, prices are set by adding a markup to a product’s cost. The markup is usually a percentage.

A-2 The price elasticity of demand measures the degree to which a change in price affects unit sales. The unit sales of a product with inelastic demand are relatively insensitive to the price charged for the product. In contrast, the unit sales of a product with elastic demand are sensitive to the price charged for the product.

A-3 The profit-maximizing price should depend only on the variable (marginal) cost per unit and on the price elasticity of demand. Fixed costs do not enter into the pricing decision. Fixed costs are relevant in a decision of whether to offer a product or service at all, but are not relevant in deciding what to charge for the product or service once the decision to offer it has been made. Because price affects unit sales, total variable costs are affected by the pricing decision and therefore are relevant.

A-4 The markup over variable cost depends on the price elasticity of demand. A product whose demand is elastic should have a lower markup over cost than a product whose demand is inelastic. If demand for a product is inelastic, the price can be increased without as drastically reducing unit sales.

A-5 The markup in the absorption costing approach to pricing is supposed to cover selling and administrative expenses as well as providing for an adequate return on the assets tied up in the product. Full cost is an alternative approach not discussed in the chapter that is used almost as frequently as the absorption approach. Under the full cost approach, all costs—including selling and administrative expenses—are included in the cost base. If full cost is used, the markup is only supposed to provide for an adequate return on the assets.

A-6 The…...

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