Average Cost Pricing Rule - Explained
What is the Average Cost Pricing Rule?
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Table of ContentsWhat is the Average Cost Pricing Rule?How does the Average Cost Pricing Rule Work? Average-Cost Pricing vs. Marginal-Cost PricingAcademics Research on Average Cost Pricing Rule
What is the Average Cost Pricing Rule?
The average cost pricing rule is a policy used by regulators to set prices of goods and services equal or close to the average cost of manufacturing the product. This pricing rule is sometimes used by the government or regulators to mandate a monopoly to charge prices equal to the average cost of production. When regulators impose price limits on certain businesses, it means such businesses will change the unit price of a product to match the average cost of producing it.
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How does the Average Cost Pricing Rule Work?
The average cost pricing rule is a pricing strategy that helps regulators and governments impose a limit on what businesses can charge for their goods and services. This rule helps to maintain normal prices on goods and services without causing any shortfall to business owners. This pricing rule is otherwise referred to as sales maximization because it guarantees maximum sales of goods and services and also helps businesses maintain normal profits.
The average cost pricing rule is mostly used in perfect competition, where companies can make normal profits. It is also a pricing strategy imposed on legal monopolies given that economies of scale can be attained. Companies that want to increase their market share without necessarily making maximum profits can also use the average cost pricing method. Many economists and studies have shown support for the implementation of average cost pricing strategies. This pricing strategy can be imposed on businesses, whether large, medium or small scale.
When an average cost pricing rule is implemented, it means that businesses must set prices close to the marginal cost of products or the average cost of producing goods and services. The average cost pricing strategy is often used as a regulatory policy for legal monopolies and sometimes oligopoly. It is used in oligopoly only when the price set enhances sales maximization and the company is not at a loss. In this strategy, the price set for goods and services is equal or close to the average total cost of production. This pricing method guarantees normal profits for organizations and also increase sales margin.
Average-Cost Pricing vs. Marginal-Cost Pricing
When the price set for goods and services equals the marginal cost of producing the goods, a marginal cost pricing strategy is in place. Similar to an average cost pricing rule, a marginal cost pricing rule is also a regulatory policy imposed on business. The distinguishing factor between the two pricing strategies is that the average cost pricing guarantees a normal profit for businesses, especially natural monopolies, while the marginal cost pricing does not.
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