Which of the following statements is true of average-cost pricing?
In a typical situation, the average cost per unit increases as the quantity produced increases.
It is possible to compute average cost without a quantity estimate.
Average-cost pricing works well if the firm actually sells the quantity it used to calculate the average-cost price.
Average-cost pricing always takes into consideration competitors’ ?costs and prices.
The Correct Answer and Explanation is :
The correct statement is:
“Average-cost pricing works well if the firm actually sells the quantity it used to calculate the average-cost price.”
Explanation:
Average-cost pricing refers to the pricing method where a firm sets its price by calculating the average cost of producing a certain quantity of goods and adding a markup for profit. This method is often used by firms to ensure they cover their costs and achieve a desired profit margin. Let’s break down the other statements to understand why this particular one is true:
- “In a typical situation, the average cost per unit increases as the quantity produced increases.”
- This is not typically true. In the short run, average cost often decreases as the quantity produced increases due to economies of scale. Larger production quantities spread fixed costs over more units, lowering the average cost per unit. However, in the long run or in certain situations with limited resources, average costs could rise as production increases due to diseconomies of scale. So, this statement is not universally accurate.
- “It is possible to compute average cost without a quantity estimate.”
- This is false. To calculate the average cost, you need both total costs (fixed and variable) and the quantity produced. The average cost is computed as:
[
\text{Average Cost} = \frac{\text{Total Cost}}{\text{Quantity Produced}}
]
Without knowing the quantity produced, the average cost cannot be determined.
- “Average-cost pricing works well if the firm actually sells the quantity it used to calculate the average-cost price.”
- This is true. If a firm uses average-cost pricing to set a price based on a specific quantity and ends up selling exactly that quantity, it ensures that the firm will cover its costs and make the desired profit. However, if the firm sells more or less than the estimated quantity, the pricing may not be optimal, as it would not fully account for changes in cost structure (such as lower per-unit costs for larger quantities or higher per-unit costs for lower quantities).
- “Average-cost pricing always takes into consideration competitors’ costs and prices.”
- This is false. Average-cost pricing focuses on the firm’s own costs and does not necessarily consider the prices set by competitors. While firms may use competitors’ prices as a reference point, cost-plus pricing (a different pricing strategy) would be more concerned with competitors’ costs and prices.
Thus, the key point in average-cost pricing is that it works best when the firm sells the exact quantity it used to calculate the average cost, ensuring that the price covers the costs and results in a profit.