Marginal- cost pricing

Marginal- cost pricing

Marginal-cost pricing, in economics, the practice of setting the price of a product to equal the extra cost of producing an extra unit of output. By this policy, a producer charges, for each product unit sold, only the addition to total cost resulting from materials and direct labour. Businesses often set prices close to marginal cost during periods of poor sales. If, for example, an item has a marginal cost of $1.00 and a normal selling price is $2.00, the firm selling the item might wish to lower the price to $1.10 if demand has waned. The business would choose this approach because the incremental profit of 10 cents from the transaction is better than no sale at all.

In the mid-20th century, proponents of the ideal of perfect competition-a scenario in which firms produce nearly identical products and charge the same price-favoured the efficiency inherent in the concept of marginal-cost pricing. Economists such as Ronald Coase, however, upheld the market's ability to determine prices. They supported the way in which market pricing signals information about the goods being sold to buyers and sellers, and they observed that sellers who were required to price at marginal cost would risk failing to cover their fixed costs.