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On the optimality of the full-cost pricing

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  • Thépot, Jacques
  • Netzer, Jean-Luc

Abstract

Most companies prefer to use absorption costing rule rather than marginal cost pricing. This article is aimed at defining the absorption costing rule as deriving from a principal-agent formulation of two tier organizations : (i) the upstream unit fixes the production capacity and uses it as a cost driver to compute the average cost (ii) the downstream unit operates on the market and chooses the output level on the basis of the average cost. Absorption costing results in two policies to be used according to the magnitude of the fixed cost. When the fixed cost is low, the capacity is fully used and a full cost pricing policy holds; when the fixed cost is high, a partial cost pricing policy holds since only a part of the fixed cost is passed on. The absorption costing rule competes with three pricing rules related to this two-tier structure and various payoffs functions associated to the decision levels: the separation, the tranfer pricing and the integration These rules are analyzed in the Cournot oligopoly case and comparisons in terms of profits are made. Except in the monopoly case, there exists a wide range of values of the fixed cost, for which the full cost pricing dominates all the other rules. In addition, there exists a specific value of the fixed cost for which the full cost pricing duplicates the monopoly and then leads to the first best solution of the Cournot oligopoly.
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Suggested Citation

  • Thépot, Jacques & Netzer, Jean-Luc, 2008. "On the optimality of the full-cost pricing," Journal of Economic Behavior & Organization, Elsevier, vol. 68(1), pages 282-292, October.
    • Handle: RePEc:eee:jeborg:v:68:y:2008:i:1:p:282-292
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    Cited by:

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    2. Jacques Thépot, 2013. "Investissement et financement dans un monopole avec bénéfices privés," Working Papers of LaRGE Research Center 2013-02, Laboratoire de Recherche en Gestion et Economie (LaRGE), Université de Strasbourg.
    3. Jacob P. Gramlich & Korok Ray, 2015. "Reconciling Full-Cost and Marginal-Cost Pricing," Finance and Economics Discussion Series 2015-72, Board of Governors of the Federal Reserve System (U.S.).
    4. Kamphorst, Jurjen & Mendys-Kamphorst, Ewa & Westbrock, Bastian, 2020. "Fixed costs matter even when the costs are sunk," Economics Letters, Elsevier, vol. 195(C).
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    6. Chi-Chih Lin, 2016. "Can Total Deregulation Be A Better Option Than Partial Deregulation?," The Singapore Economic Review (SER), World Scientific Publishing Co. Pte. Ltd., vol. 61(04), pages 1-16, September.

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    More about this item

    JEL classification:

    • D4 - Microeconomics - - Market Structure, Pricing, and Design
    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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