AP Business with Personal Finance · Lesson 3

Price, place and promotion

Know Know it

A price must cover costs, match what customers think the product is worth, and fit the competition. Cost-plus pricing adds a markup to the cost: a 50 percent markup on a 40 dollar cost gives 40 x 1.5 = 60 dollars. Competition-based pricing sets the price near rivals’ prices. Value-based pricing sets it by how much the product is worth to the buyer. For new products, price skimming starts high for eager early buyers, and penetration pricing starts low to win share fast. Other strategies include psychological pricing (9.99 dollars instead of 10), prestige pricing (a high price that signals quality), bundling, dynamic pricing that changes with demand, and loss leaders sold below cost to bring shoppers in.

Every unit sold earns its contribution margin: price minus variable cost per unit. Fixed costs (rent, salaries, insurance) stay the same whatever the output, and variable costs (materials, packaging) rise with each unit. The break-even point is fixed costs divided by contribution margin per unit. Above it, each extra unit adds its contribution margin to profit. Price elasticity of demand tells how buyers react to a price change: demand is elastic when there are many substitutes or the item is a luxury, so a price rise loses many sales and can lower revenue; it is inelastic for necessities with few substitutes, so a price rise loses few sales and raises revenue.

Place is how the product reaches buyers. A direct channel goes from producer to consumer; indirect channels use intermediaries such as wholesalers (who buy in bulk and resell in smaller lots), retailers, and agents or brokers (who arrange sales without owning the goods). Intermediaries cut the number of contacts and handle storage and selling, but each takes a share of the price. Intensive distribution puts a product in as many outlets as possible (snacks), selective distribution in a chosen few (mid-priced appliances), exclusive distribution in one or very few (luxury goods). Selling through many channels at once is omnichannel retailing; when a producer competes with its own retailers, the result can be channel conflict.

Promotion tells customers about the product and persuades them to buy. The promotion mix has advertising (paid messages in media), personal selling (one-to-one, best for costly or complex products), sales promotion (coupons, samples, contests), public relations (news coverage and events that build goodwill) and direct and digital marketing (email, social media, search ads). The AIDA model says promotion should win attention, interest, desire, then action. A push strategy aims promotion at the channel; a pull strategy aims it at final customers. Useful measures include cost per thousand people reached (cost / audience x 1,000), click-through rate (clicks / times shown) and return on investment ((gain - cost) / cost). Advertising must be truthful: deceptive claims are against the law.

Trap Break-even divides by the margin, not the price

Each unit pays off fixed costs only with what is left after its own variable cost. So divide fixed costs by price minus variable cost, not by the price alone. Dividing by the price makes the break-even point look far too low.

Worked example Easy

A fictional gift shop buys a lamp for 40 dollars and uses cost-plus pricing with a 50 percent markup on cost. What price does it charge?

  1. 20 dollars
  2. 60 dollarsAnswer
  3. 80 dollars
  4. About 26.67 dollars

How to solve it

  1. Markup = 50 percent of 40 = 20 dollars.
  2. Price = cost + markup = 40 + 20 = 60 dollars.
  3. Equivalently, 40 x 1.5 = 60 dollars.

Why each choice is right or wrong

  • A. Incorrect. 20 dollars is the markup alone, 50 percent of 40, not the price the shop charges.
  • B. Correct. Price = cost x (1 + markup) = 40 x 1.5 = 60 dollars.
  • C. Incorrect. 80 dollars doubles the cost, a 100 percent markup, not a 50 percent one.
  • D. Incorrect. About 26.67 dollars divides 40 by 1.5, which gives a price below the cost.

Explain Explain it

Task verbs: calculate, compare

For break-even, first find the contribution margin per unit, then divide fixed costs by it. Show both steps so a reader can follow.

To compare promotions, put them on the same basis: cost per thousand people reached, or return on investment, which counts the gain left after paying for the promotion.

Worked example Medium

A fictional company sells phone stands for 30 dollars each. Each stand costs 12 dollars in materials and packaging, and its fixed costs are 18,000 dollars a year. How many stands must it sell in a year to break even?

  1. 600
  2. 1,500
  3. 429
  4. 1,000Answer

How to solve it

  1. Contribution margin per stand: 30 - 12 = 18 dollars.
  2. Break-even: 18,000 / 18 = 1,000 stands.
  3. Each stand after the 1,000th adds 18 dollars of profit.

Why each choice is right or wrong

  • A. Incorrect. 600 divides 18,000 by the 30 dollar price and ignores the 12 dollar variable cost of each stand.
  • B. Incorrect. 1,500 divides 18,000 by the 12 dollar variable cost, not by the margin each stand earns.
  • C. Incorrect. 429 divides 18,000 by 42, the price plus the variable cost; the cost must be subtracted, not added.
  • D. Correct. Each stand earns 30 - 12 = 18 dollars toward fixed costs, and 18,000 / 18 = 1,000 stands.

Calculate Your turn

A fictional bakery, Rye & Rise, ran two promotions in different months. Each cost 2,000 dollars. An email coupon brought in 5,000 dollars of extra gross profit, and a radio ad brought in 2,600 dollars of extra gross profit. Calculate the return on investment of each promotion, using (gain - cost) / cost, and say which promotion gave the better return.

Write it, then compare. Nothing you type here is saved or graded.

Compare with a model answer

A full answer does this

  • Calculates the email coupon’s return as 150 percent
  • Calculates the radio ad’s return as 30 percent
  • Names the email coupon as the better return

Model answer

Email coupon: (5,000 - 2,000) / 2,000 = 3,000 / 2,000 = 1.5, a return of 150 percent. Radio ad: (2,600 - 2,000) / 2,000 = 600 / 2,000 = 0.3, a return of 30 percent. The email coupon gave the better return, 150 percent against 30 percent: each dollar spent on it brought 1.50 dollars of gain beyond its cost.

Apply Apply it

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