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Ascertaining Productivity For Estimating Costing Margin

  Ascertaining Productivity for estimating costing margin

            The selected productivity used for the purpose of estimating costing margin can be ascertained in several ways. First it may be fixed on the basis of capacity productivity of the provided plant when by the capacity productivity is meant the optimum productivity can be manufactured with the provided plant.

            Productivity can be fixed by a business industry as some percentage of this capacity productivity. Secondly, the selected productivity can be predetermined on the basis of sales of commodity made in the preceding manufacturing period or average of sales accomplished over a number of previous manufacturing periods.

            Thirdly the productivity may be ascertained on the basis of expected sales in a future period for which productivity is being manufactured. If a fresh industry has to set the price of its commodity has introduced a fresh commodity for which it has to predetermined the price, the above mentioned second way of choosing the productivity for estimating the costing margin is ruled out and in these circumstances only the first and third modes become relevant.

            Indeed when the industry is a new one or when a subsisting industry is introducing a fresh commodity then the first and third modes of selecting productivity volume to the same thing. This is for the reason that designed capacity of the plant will be ascertained by the anticipated sales of the commodity in the prospect.

            In the above diagram let us presume that the industry has chosen productivity ON for estimating costing margin and for fixing price of the commodity. Further, presume that if the provided that at ON it capitulates MG volume which will be the costing margin to be added to the average direct cost for ascertaining the price of the commodity.

            It will be observed in the diagram that at ON level of productivity, average direct cost in NM. If we add costing margin MG to NM, we get full cost paritying to NG. Therefore, the price OR will be predetermined paritying to full cost NG. It should be noted that price OR fixed on the basis of full cost NG will stay unvaried whatever the volume demanded and the actual productivity manufactured in the provided phase.

            Now, if the demand for the commodity is provided by the curve DD’, then it will be observed from the diagram, that at price OR, volume of the commodity will be demanded and thus manufactured.

            Now, even if the demand for the commodity enhances or reduces the price will stays unaltered at OR, given the volume demanded falls inside the range of invariable average direct cost i.e. inside its horizontal straight line portion and additional given that costing margin stays unchanged.

            Therefore, we observe that as per Andrew version of cost plus pricing thesis, price will vary consequent to variations in direct and indirect costs of manufacturing and not consequent to variation in demand.

            Therefore, as per to cost plus thesis “The price will not be variation in response to variations in demand but only in response to variations in the prices of the direct and indirect aspects.

Squaring off of Cost Plus Pricing with Marginal study

From the study of the association among Rate R, elasticity e and marginal revenue MR that,

                                    R         =          MR e / e-1

As at symmetry, MR = MC, it follows that

                                     R         =          MC e / e-1

Now if invariable costs triumphs, as is commonly the case in the real world and is also presumed in cost plus pricing thesis, then marginal cost MC in equation (1) we obtain,

                        R         =          AVC e / e11

                        R         =          AVC ( e-1       +     1 )
                                                        ( e-1             e-1)

                                    =          AVC (1 +)
                                                              e-1

                        R         =          AVC + AVC 1          
                                                                 e-1

    Thus Rate                   

                        R         =          AVC + Mark-up, therefore, on the basis of profit optimisation presumption, mark-up or costing margin parities to AVC 1 / e-1.

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