Question

1.How would a manager use economic theory to determine profit-maximizing price for a service or product?

2. What is the process of target costing? How is target cost calculated?

Answer 1

Answer 1:

Economic theory enable managers to make sense out of confusion. The real world is no doubt complicated. There are an infinite number of variables which keep on changing continuously. In fact, theory ena­bles them to discriminate between relevant and irrele­vant variables. The theoretical structure permit managers to concentrate on a few important forces and ig­nore others.

The ability to select important factors (issues) and ignore insignificant ones enables managers to tackle the problems they are faced with. This, in its turn, helps managers to know what information is useful in making decisions and what is not.

To recall, a major role of a manager is obtaining and processing information. It is the task of eco­nomic theory to give a clear indication to a manag­er what information is relevant to the decision at hand and how to use that information.

There is an economic theory of demand and supply which assist managers to understand how prices of products and services are highly influenced by their level of demand and supply in market. In case the demand of a product is high in the market but its supply is low then manager of the company would surely raise the products' price and vice versa.

Also there is an economic theory which help the managers to decide the profit maximizing price of the product.The easiest thing to understand is that producers want good value for their products and consumers are willing to spend in accordance with the utility. Equilibrium means a state of no change. Evidently, at the equilibrium price, both buyers and sellers are in a state of no change. Technically, at this price, the quantity demanded by the buyers is equal to the quantity supplied by the sellers. Both market forces of demand and supply operate in harmony at the equilibrium price.

Answer 2: Process of target costing involve:

1. Conducting Market Research: The company should determine the customer wants precisely through conducting marketing research.

2. Identify the Nature of Market: The market information can be collected in such a way that what type of products are available in the market, the level of competition prevailing, the number of competitors and the price at which the existing products are available. Besides, the company should find out the affordable price of the customers. If so, the target costing is followed.

3. Translation of Customers Requirements into Product Features: The preference of one customer differs from another. These preferences are collectively called as customers requirements. Now, the bundle of preferences are bringing into a tangible thing i.e. product

4. Development of a Product Design: By considering the engineering analysis of market forces, customer needs, relevant technology, competitors models, product configuration and performance features, design alternatives, process capabilities, maintenance and service requirements etc., a suitable product design is to be determined by the company.

5. Determine the Price, Margin and Cost: Target selling price is determined on the basis of market survey, at which the product can be sold. The standard margin is also included in the target selling price. If so, it is possible to determine the target cost

6. Conducting Value Engineering Process: The company can conduct value engineering process to reach target cost

7. Improve the Design to Reach Target Cost: The company starts a minor trial production. Such a production ensures all product performances, target cost and target profit margin also.

8. Approval of Top Management: A detail report is presented before the top management for getting approval.

9. Maintenance of Accounts: A separate accounting records are to be maintained for each product design. It is possible to verify whether the total expenses exceed the target cost

10. Implement the Target Costing: The company can get the information regarding the expenses incurred for each design separately. A continuous watching is essential to bring the total cost within the target cost.

Target Cost Calculation

Where the profit margin is based on selling price, target total cost can be calculated as follows:

Target cost
= Selling Price – Profit % × Selling Price

Where the profit margin is based on cost, target cost can be found as follows:

Target CostSelling Price1Profit Percentage

Targets can be set for each individual cost component based on the standard costing.