An evaluation of a formula method of price determination

195 Pages·08.573 MB·English

by  Sherry, Benjamin Berry

AN EVALUATION OP A FORMULA METHOD
OP PRICE DETERMINATION
A Thesis
Presented to
the Faculty of the School of Commerce
The University of Southern California
In Partial Fulfillment
of the Requirements for the Degree
Master of Business Administration
fcy
Benjamin Berry Sherry
June 1950
UMI Number: EP43273
All rights reserved
INFORMATION TO ALL USERS
The quality of this reproduction is dependent upon the quality of the copy submitted.
In the unlikely event that the author did not send a complete manuscript
and there are missing pages, these will be noted. Also, if material had to be removed,
a note will indicate the deletion.
Dissertation Publishing
UMI EP43273
Published by ProQuest LLC (2014). Copyright in the Dissertation held by the Author.
Microform Edition © ProQuest LLC.
All rights reserved. This work is protected against
unauthorized copying under Title 17, United States Code
ProQuest LLC.
789 East Eisenhower Parkway
P.O. Box 1346
Ann Arbor, Ml 48106- 1346
com n3A
' '
This thesis, written by
sherry
■ ..............
under the guidance of h.%3... Faculty Committee,
and approved by all its members, has been
presented to and accepted by the Council on
Graduate Study and Research in partial fulfill­
ment of the requirements for the degree of
MASTER OF
BUSINESS ADMINISTRATION
Date.............
Faculty Committee
W-B. Walt
Chairman
lton
E a ;
Rex Has
TABLE OF CONTENTS
CHAPTER PAGE
I. THE PROBLEM AND DEFINITIONS OF TERMS USED . . 1
The problem................... 2
Statement of the problem ......... 2
Importance of the study • • • .......... 2
Definitions of terms used ............ . . • 5
Formula method of price determination . . 3
Full cost m e t h o d ...............• • • • 4
Alternative method . . ................. 4
Profit . . . . . . . . . 4
Required profit......................... 5
Accounting profit ................... 5
Pure profit ........................ 5
Material cost • • • • • . . •• 6
Conversion cost.......... 6
Selling c o s t ......................... 6
Normal capacity ................... 6
Manufacturing overhead .. ........... 7
Price............... 7
Organization of the remainder of the thesis 7
II. REVIEW OF THE LITERATURE................... 10
Literature on investigations of the princi­
ple of full c o s t ................... 10
Literature on investigations of an alterna­
tive formula method of price determination 12
U i
CHAPTER PAGE
Literature on actual price determination • 14
Literature on marginal concepts of economic
analysis and the function of profits • • 15
Limitations of previous studies . . 17
III. FULL COST METHOD OF PRICE DETERMINATION- BY
MEANS OF A F OR MULA .............. 19
The constituents of full cost.... 19
The computation of profit based on a per­
centage of full c o s t * 20
Implied or actual use of capacity as a
requirement of price determination • . • 21
General formula for determining price based
on the full cost method • • • • • • • • 24
Theoretical considerations underlying the
full cost m e t h o d .............. 25
Business enterprise organized for the
anticipation of profit earnings • • • . 26
Profit expectations determine the channel­
ing of resources • • • • • • • • • • • 27
The marginal preferences of consumers . * 28
Sales value of the marginal product as a
measure of consumer preferences’. . . . 31
iv
CHAPTER PACE
Profit considered as the residual of total
revenues minus total cost ............. 51
Prevalence of the full cost method of
price determination................... 33
In retailing industries • • ........... 33
In manufacturing industries.......... 33
Summary.................................... 35
IV. AN ALTERNATIVE FORMULA FOR PRICE DETERMINATION 37
The constituents of c o s t ................. 37
A general alternative formula for pricing • 38
Basis for Knoeppel*s formula • • • • • • 38
Basis for Churchill!s formula • • • • • • 39
Presentation of Churchill1s formula • • • • 40
Rearrangement of the elements........... 41
Theoretical considerations underlying the
alternative formula • • • . • • • • • • • 42
Pragmatic investigations by Churchill • • 42
Basis for selling cost equaling required
profit 43
Basis for not calculating a portion of re­
quired profit on material cost . . . . 44
Basis for the use of normal capacity . . 44
V
CHAPTER PAGE
Justification for considering realized
profit as a requirement of business
enterprise • • • • • • • • ......... • 45
Justification in economic theory • . . 45
Justification in prevailing business
thought..................... .. 43
Justification in considering selling
costs independent of costs of production 49
Justification for not calculating per­
centage profit on material cost and
selling costs ....................... 51
Justification for the use of normal
capacity....................... .. 58
Reconciliation of full cost method and alter­
native method ................... 58
Restatement of the full cost principle and
its mathematical computation • • • • • 59
Computation of the addition for profit
or m ar k-up .......... 59
Implied acceptance of profit, in part,
based on conversion cost under the
full cost m e t h o d ............... • • 60
vi
chapter page
Elimination of material cost and selling
cost from the full cost m e t h o d ...... 60
Reconciliation of the X% mark-up and the
ratio developed by Churchill • • • • • • 61
Summary • • • • « • • ........................... 63
V. THEORETICAL COMPARISON OP PRICES COMPUTED BY THE
PULL COST METHOD AND THE ALTERNATIVE METHOD
UNDER ASSUMED CONDITIONS.................. 66
Attributes of price • • • • • • • * • .. ......... 68
Comparative prices computed by the full cost
method and the alternative method under the
influence of a changing price level • • . ♦ • 71
Limitations of both methods................ 74
Agreement with the criterion............ 74
Disagreement with the criterion • • • • » • • 74
Cause of disagreement due to fixed indirect
cost • • • • • • • • • • • • • ............... 76
Suggested modification of the alternative
method to correct deficiency ................. 80
Comparative prices computed by the full cost
method and the alternative method under the
influence of a declining price level and
declining demand .............. . . . . 81
Comparative prices with a declining price
level, elasticity of supply greater
vii
CHAPTER - PAGE
than one . • 82
Comparative prices with a declining price
level, elasticity of supply equal to 1*7 85
Comparative prices with a declining price
level, elasticity less than one . • • • 80
Table of summary of results • • • • • • « • 91
Agreement with criterion of price • • . • . 91
Disagreement with criterion of price . . . 95
Causes of disagreement due to fixed indirect
costs.......... 94
Price computed by full cost method more in
agreement with actual theoretical results 94
Causes of more consistent results . . . . 95
Synthesis of full cost method and alternative
method • • • • • « • • ............... • 96
Use of alternative method to compute X% for
mark-up of the full cost method . . • • 96
Modification of alternative formula • • . . 97
Limitations of the modified formulas . . . 98
Basic assumptions « • • • • • • • • • • • 99
Criticism of profit ratio.......... . . 100
Criticism of effective selling effort . . 101
Summary .......................... • • • • « 101
viii
CHAPTER PAGE
VI. SUMMARY AND CONCLUSIONS............ 104
Summary........................... 104
Conclusions............ ......... 112
BIBLIOGRAPHY............................. 118
APPENDIX. EXAMINATION OP THE ALTERNATIVE FORMULA
BY MARGINAL CONCEPTS ..................... .121
APPENDIX A. Hypothetical d a t a .......... 123
APPENDIX B. A formula method of pricing applied to
pure competition .............. 131
APPENDIX C. A formula method of pricing applied to
simple monopoly • • • • » • • • • • 153
APPENDIX D. A formula method of pricing applied to
oligopoly and monopolistic competition 166
APPENDIX E. Summary of appendix• • • • • • • • • 173