Pricing Management in Market Economy

9:52:21 AM | 6/11/2024

Financial management is decisive to business subsistence and development. Therefore, businesses always prioritize the formulation of pricing strategies to govern the valuation of their products. Prices are set to optimize profitability per unit sold, strategically leveraging pricing mechanisms to safeguard existing market positions or to penetrate novel market segments.

Figure 1: Price and allocative efficiency

The pricing strategy often determines business success or failure, so pricing is crucial. Economist Adam Smith said the "invisible hand" of the market relies on price changes. In particular, commodity prices play an important role in determining the effective distribution of resources in the market because prices act as signals for shortages and surpluses, helping companies and consumers react to market condition changes. Allocative efficiency is said to occur when the marginal utility (MU) from a good is equal to the marginal cost (MC). This allocative efficiency will be achieved at the QM output level where the PM market price equals marginal cost (Figure 1). Or in other words, when supply curve S meets demand curve D.

If goods are scarce, prices will tend to increase, stimulating companies to try to increase supply, and conversely, if goods are in excess, prices will tend to go down, encouraging buyers to purchase and leading companies to supply cuts. Prices also help redistribute goods that are less in demand to goods and services that are more highly valued by consumers.

Figure 2: Reduced supply causes higher prices

Agriculturally, when a crop fails, agricultural output falls from Q1 to Q2 (the supply curve of goods shifts from S1 to S2), resulting in an increase in commodity prices from P1 to P2. In the short term, demand D is not price-elastic, so demand only decreases slightly and insignificantly (Figure 2). When the harvest is good, agricultural supply looks up, causing product prices to go down (depreciate) if businesses do not have solutions to diversify and develop more market shares.

However, the market does not stand still. If the price moves up from P1 to P2, the profit of agricultural products increases and then the business has greater revenue than cost.

High prices are a driving force for businesses to boost output. Thus, over time, higher prices induce more investment in the field (Figure 3) and the supply S2 rebounds to the long-run supply level SLR with a more suitable price.

Figure 3: High agricultural product prices prompt more long-term agricultural investment

Consumers are one of the three actors of the market economy and have a strong impact on product prices, and vice versa, prices affect consumer behaviors. We can illustrate the interaction between consumers and high oil prices as a result of a supply crisis that causes output to decrease from Q1 to Q2 (Figure 4). In the short run, the demand curve is inelastic with price. However, the depletion of this type of resource certainly affects consumer behavior, so they will look to buy motorbikes, cars with better fuel efficiency or look for other alternative means such as bicycles and public vehicles, leading to a gradual contraction in demand for fossil fuels. That is the development opportunity of the green energy industry to respond to this change. Furthermore, this is also the time for developing countries to take advantage of advanced technology to boost competitive advantages in economies of scale in restructuring transport infrastructure to move forward to public transportation such as buses, trains and high-speed rail. In the long term, with increased investment in alternative energy and demand for fossil fuels, Q2 output continues to shrink QLR, leading to a decline in gasoline prices according to market laws.

Figure 4: Price affects consumer behavior

To further actively promote the pricing role and function in financial resource management, when planning product and service pricing strategies, it is necessary to further study in the three following areas:

First, given impacts of international factors, commodity prices can move erratically, causing underconsumption or overconsumption, giving rise to inadequacies in operating the domestic market economy, export and import.

Second, prices help shift resources to areas of greatest need, but they can lead to unfair distribution, resource depletion, and inequality in the environmental and social spheres. In particular, in an economy where land belongs to all people, pricing depends greatly on planning and legal regulations relating to land use purposes. What is more, it should be noted that the real estate market and the financial market have a symbiotic relationship in the market economy, so it is necessary to manage prices well in these two areas to avoid crises. In times of natural disasters, armed conflicts, and epidemics that cause scarcity of essential goods and services, leading to rising prices and affecting people's needs, it is necessary to have a fair distribution plan rather than profit-driven distribution and escalating market prices.

Third, in monopolistic situations, group interests and a nontransparent competitive environment in real estate, equitization of state-owned enterprises, public investment, bidding, tariff, stock market, cross-bank ownership, higher or lower prices may not reflect a shortage or surplus of goods but show that monopoly power results in inefficient allocation due to profiteering and corruption that distort market operations and stagnate the economy.

Perhaps, a product cost strategy (including building pricing methods, implementation measures as well as inspection and auditing processes) plays a key role in ensuring the construction and development of institutions and synchronized structure for the financial market. Financial resource management must be first objective and accurate valuation to create liquidity to exploit and optimize other resources such as people, production and resources to foster human innovations, as well as mobilize all capital sources for sustainable economic development.

Dr. Doan Duy Khuong  (Vietnam Business Forum)