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Subject P2: Advanced Management Accounting
CHAPTER 8 – THE PRICING DECISION
8.1 $78.50
General fixed costs are not relevant to our calculations.
To maximise profits, a firm should produce units up to the point where the
marginal revenue equals the marginal cost: MR = MC
The basic price equation is given as p = a + bx, with
b = (change in price/change in quantity)
b = $12/175 units = 0.0686
Present quantity 350
‘a’ = Selling Price now $98 + ( ) × change in selling price $12
Change in units 175
a = $122
The marginal revenue equation can be found by doubling the value of b:
MR = a + 2bx
The marginal cost is the variable cost of production $35.00
P = $122 – 0.0686 x
MR = 160 – 0.1371428 x
MC = $35
Profit is maximised when MC = MR so 35 = 122 – 0.1371428 x
87 = 0.1371428 x
x = optimum quantity of 634.38 units
P = $122 – 0.0686 x
Therefore P = $122 – (0.0686 × 634.38 units) = $78.50
8.2 B
Cost-plus pricing applies a standard mark-up to products. It therefore takes no
account of price elasticity nor provides flexibility during the product’s lifecycle so
options 1 and 3 are wrong. If a company produces at a lower volume than
expected then full overheads will not be recovered and so option 3 is wrong.
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