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Chapter 3: Price and Pricing Strategies

MULTIPLE CHOICE 1. New entrepreneurs often set the price of their products or services by adding up all the costs involved in bringing the product or service to market and then adding a specific amount for profit. What is this approach known as? a. Profit-based pricing b. Demand-supply pricing c. Cost-plus pricing d. Pioneering pricing ANS: C New entrepreneurs often set the price of their products or services by adding up all the costs involved in bringing the product or service to market and then adding a specific amount for profit (say, 15 percent). This approach is referred to as cost-plus pricing. REF: 3-1 2. Which of these is not an implication of the supply-demand-price equation, considering a free marketplace with willing buyers and willing sellers? a. If supply is static and demand falls, prices will fall b. If demand is static and supply decreases, prices will rise c. If supply is static and demand increases, prices will fall d. If demand is static and supply increases, prices will fall ANS: C The supply-demand-price equation assumes a free marketplace with willing buyers and willing sellers. Under these conditions, the formula has four implications regarding price: 1. If supply is held static and demand increases, prices will rise, 2. If supply is static and demand falls, prices will fall, 3. If demand is static and supply increases, prices will fall, and 4. If demand is static and supply decreases, prices will rise. REF: 3-2 3. ____ is an attempt to affect demand through alteration of prices. a. Revenue strategy b. Marketing strategy c. Price strategy d. Positioning strategy ANS: C Price strategy is an attempt to affect demand through alteration of prices. REF: 3-2 4. What are the types of demand identified by economists in free markets? a. National, international b. Elastic, inelastic c. Open, restrictive d. Fixed, adaptive ANS: B

Economists recognize two basic types of demand in free markets: 1. Elastic 2. Inelastic REF: 3-2 5. Identify the market in which the overall demand in the market will expand if prices are lowered. a. Elastic market b. Restrictive market c. Open market d. Inelastic market ANS: A An elastic market is one in which the overall demand in the market will expand if prices are lowered. REF: 3-2 6. Identify the term that recognizes a market in which demand will not respond to price changes. a. Open market b. Restrictive market c. Elastic market d. Inelastic market ANS: D An inelastic market is one in which demand will not respond to price changes. REF: 3-2 7. It is noticed that as competition escalates among carriers and as ticket prices drop, people tend to fly more frequently. Which market does this example illustrate? a. Barrier market b. Inelastic market c. Restrictive market d. Elastic market ANS: D As competition escalates among carriers and as ticket prices drop, people tend to fly more frequently. The demand for air travel is highly elastic and very sensitive to price. REF: 3-2 8. It is found that in an inelastic market, any increase in the market share for one competitor has to be at the expense of one or more of the others. Any price-cutting strategy in such a market is likely to be matched by the competition. What is the consequence of this competitive reaction? a. It leads to introducing value-added services to customers b. It leads to lower frequency of air travel c. It leads to the identification of the competitors core competencies d. It leads to price wars ANS: D In an inelastic market, any increase in market share for one competitor has to be at the expense of one or more of the others. Therefore, any price-cutting strategy in such a market is likely to be matched by the competition. This competitive reaction leads to price wars. REF: 3-2

9. Which of the following statement is not true with regard to elastic markets? a. Price reductions can lead customers to buy the price-cutters product or service instead of the competitors products b. Competitors will react to any substantial loss of customers caused by a reduction in prices c. Price reductions can lead to more buyers coming into the market, thereby expanding the market d. No matter what the price of the product is set at, people simply will not buy more than normal ANS: D In an elastic market, the reduction of prices by a competitor has two potential consequences: 1. It can lead to more buyers coming into the market, thereby expanding the market, and 2. It can lead customers to buy the price-cutters product or service instead of the competitors products. REF: 3-2 10. ____ is the difference between the selling price of a product or service and the amount the entrepreneur had to pay for the raw materials that make up that product or service. a. Return on investment b. Average margin c. Profit margin d. Gross margin ANS: D Gross margin is the difference between the selling price of a product or service and the amount the entrepreneur had to pay for the raw materials that make up that product or service (the cost of goods sold). REF: 3-2 11. ____ is expressed as a percentage of revenue, using the following equation: Gross margin = (Revenue Cost of goods sold) / Revenue a. Gross margin b. Profitability c. Net worth d. Cost incurred ANS: A Gross margin is expressed as a percentage of revenue, using the following equation: Gross margin = (Revenue Cost of goods sold) / Revenue REF: 3-3 12. Why does increased sales volume lead to a reduction in the average cost of goods sold? a. Because otherwise competitors will take over market leadership b. Because consumers would prefer to buy a product in demand for lesser price c. Because the rate of supply is in lag to the demand d. Because suppliers will often provide discounts to clients that buy in large volumes ANS: D Increased sales volume can lead to a reduction in the average cost of goods sold because suppliers will often provide discounts to clients that buy in large volumes.

REF: 3-3 13. What do businesses that are able to raise prices without cost increases and without sacrificing sales volume possess? a. Pricing power b. Market advantage c. Positioning-pricing balance d. Competitor advantage ANS: A Businesses that are able to raise prices without cost increases and without sacrificing sales volume possess what is called pricing power. REF: 3-3 14. ____ are those associated with a companys most important sources of revenue, usually the companys best customers, or its most popular products or services, or those with the greatest margins. a. Positioning b. Core prices c. Consumerism d. Marketing strategies ANS: B Core prices are those associated with a companys most important sources of revenue, usually the companys best customers, or its most popular products or services, or those with the greatest margins. REF: 3-4 15. A company reduces its fourteen-ounce box of cereal to twelve ounces without changing the price on the box. Assume that this change does not result in the loss of customers. Which method did the company employ to protect their core pricing? a. Value-added innovations b. Product downsizing c. Co-branding d. Repackaging ANS: B A common method that companies use to protect their core pricing is through product downsizing. For example, a cereal maker that reduces a fourteen-ounce box of cereal to twelve ounces without changing the price on the box will not lose many customers. REF: 3-4 16. Which of the following is the most widely used pricing strategy? a. Cross-product discounting b. Packaging c. Value-added services d. Discounting ANS: D Discounting is the most widely used price strategy. REF: 3-4 17. What is the term used to refer to discounted prices that are offered for a limited time period?

a. b. c. d.

Sale Resale Rebate Clearance

ANS: A When the discounted prices are offered for a limited time period, the situation is usually referred to as a sale. REF: 3-4 18. ____ is not just aimed at directly increasing sales volume, but also to dispose of obsolete or unwanted inventory. a. Package redesign b. Value-added service offer c. Cross-product sales d. Discounting ANS: D Discounting is not always aimed directly at increasing sales volume. Discounting is also used to dispose of obsolete or unwanted inventory. REF: 3-4 19. ____ plan is one in which the recipient of the financing pays the money back in equal monthly installments. a. Credit b. Level payment c. Cross-product d. Adjusted ANS: B A level payment plan is one in which the recipient of the financing pays the money back in equal monthly installments. REF: 3-4a 20. When starting a new business, many entrepreneurs are tempted to set their prices below the general market. In this regard, which of the following statement sounds out of context? a. The rationale behind the approach is that the business is new and unknown, and needs some advantage over competitors b. To yield the business a better return on investment c. Price is often regarded to be the advantage that customers will respond to most readily d. The intent of the entrepreneurs approach is to attract customers by offering them a price advantage ANS: B When starting a new business, many entrepreneurs are tempted to set their prices below the general market. The intent of such a strategy is to attract customers by offering them a price advantage. The rationale is that the business is new and unknown and needs some advantage over competitors who have an established reputation and brand in the marketplace. Price is often regarded to be the advantage that customers will respond to most readily. REF: 3-4a

21. The strength and speed of a competitors reaction to a price change depends primarily on the effect the price has on the competitors business. In this context, how will an inelastic market react? a. The business remains unchanged b. The business will initiate both the business and its competitors to enter a price war c. It will be swifter and stronger than in other markets d. A price change may bring new customers into the market ANS: C The strength and speed of a competitors reaction to a price change depends primarily on the effect the price has on the competitors business. The reaction in an inelastic market will be swifter and stronger than in an elastic market. REF: 3-5 22. What happens to consumers once they become price sensitive? a. They tend to shop for products based on low prices b. They tend to shop based on features c. They tend to shop based on brand recognition d. They tend to shop based on value-added services ANS: A When this (dramatic price reduction) pricing pattern is continued for an extended period, consumers become price sensitive. Once in this mode, they tend to shop for products based on low prices rather than brand recognition or other features. REF: 3-5 23. Acknowledging that the airline industry is an elastic market, in the 1960s and1970s before the advent of discount or low-cost airlines, the major air carriers were able to charge prices that allowed large margins and large profits. As the airlines became more profitable, labor demanded its share of the earnings. The result was that labor costs increased, especially the cost of pilots and mechanics. When low-cost airlinessuch as Southwestentered the market, they used price strategy as the principal method of competing with the major airlines. What does this case study indicate about the pattern of pricing? a. Price reduction cycle b. Profit-pricing cycle c. Demand-pricing cycle d. Price package cycle ANS: A The airline industry is an example of the price reduction cycle in an elastic market. REF: 3-5 24. Which term refers to a rise in the general price level in a specific market? a. Depression b. Economic surge c. Inflation d. Selling margins ANS: C Inflation is defined as a rise in the general price level in a specific market. REF: 3-6

25. Identify the primary causes of inflation. i. Demand-pull inflation ii. Supply-pull inflation iii. Cost-push inflation a. b. c. d. i, ii ii, iii i, iii All of the above

ANS: C There are two primary causes of inflation: 1. Demand-pull inflation 2. Cost-push inflation REF: 3-6 26. ____ is caused by a market that is greater than the available product supply. a. Demand-push inflation b. Supply-pull inflation c. Demand-pull inflation d. Cost-push inflation ANS: C Demand-pull inflation is caused by a market demand that is greater than the available product supply. REF: 3-6 27. What is caused due to a shortage in the available supply of labor or materials that causes the cost of these items to increase? a. Cost-push inflation b. Demand-push inflation c. Supply-pull inflation d. Demand-pull inflation ANS: A Cost-push inflation is caused by a shortage in the available supply of labor or materials that causes the cost of these items to increase. REF: 3-6 28. Which of the following is used to measure the expansion of an economy? a. Gross Revenue Returns b. Gross Income Index c. Gross National Product d. Gross Domestic Product ANS: D A low inflation rate in the range of 3 percent to 4 percent is normal and even healthy in an economy that is expanding at a sustainable rate. The expansion is most often measured in terms of the gross domestic product (GDP). REF: 3-6

29. What does increase in GDP constitute? a. Increase in the labor force b. Improvement in productivity c. Inflation d. All of the above ANS: D Increases in GDP are made up of increases in the labor force, improvements in productivity, and inflation. REF: 3-6 30. On which factor does upward price adjustment of a company depend? a. On the companys clientele b. On the companys competitive position within the market c. On the demand of the companys products/ services d. On the companys return on investment in the previous year ANS: B The proper timing of any upward price adjustment for a particular company depends on its competitive position within the market. REF: 3-6 31. When a market ceases to be freely available to willing buyers and sellers, the ____ equation stops functioning. a. Profit b. Demand-supply-price c. Gross margin d. GDP ANS: B When a market ceases to be freely available to willing buyers and sellers, the demand-supply-price equation stops functioning. REF: 3-7 32. During wartime, manufacturing facilities and the civilian workforce are often converted from their normal activities to military applications. This realignment of labor and facilities causes ____. a. Labor activism b. A frictional loss of efficiency c. Price gouging d. Price and wage controls ANS: B During wartime, manufacturing facilities and the civilian workforce are often converted from their normal activities to military applications. This realignment of labor and facilities causes a frictional loss of efficiency. REF: 3-7 33. Which is the price strategy in a compromised market that are usually instituted during wartime to stem runaway inflation? a. Price and wage controls

b. Price gouging c. Dumping d. Loss leader ANS: A Price and wage controls are usually instituted during wartime to stem runaway inflation. REF: 3-7 34. What is the consequence of price and wage controls not being completely effective? a. The institution of frictional loss of efficiency caused due to realignment of labor and facilities b. The institution of excess profit tax to prevent businesses from achieving overly high profits c. The institution of dumping to undercut established market price d. The institution of price gouging to wade over catastrophic natural events or an event arranged for profit reasons ANS: B Price and wage controls are never completely effective. Consequently, an excess profits tax is usually also instituted to prevent businesses from achieving overly large profits. REF: 3-7 35. What occurs in a compromised market when the supply of an item is severely restricted by special circumstances that the demand is completely out of balance with the supply? a. Price gouging b. Dumping c. Loss leader d. Frictional loss of efficiency ANS: A Price gouging occurs when the supply of an item or items has been so severely restricted by special circumstances that the demand is completely out of balance with the supply. REF: 3-7 36. The circumstances that bring on ____ are usually either a catastrophic natural event or an event arranged for profit reasons where demand for access or accommodations near the event is excessive. a. Loss leader b. Price gouging c. Price and wage control d. Dumping ANS: B The circumstances that bring on price gouging are usually either a catastrophic natural event, such as a flood, or an event arranged for profit reasons, such as the Super Bowl, where demand for access or accommodations near the event is excessive. REF: 3-7 37. ____ refers to the disposal of goods that are surplus to their native market in a foreign market at prices below the prices in the home market or below the costs of manufacturing the goods. a. Loss leader b. Bait and switch

c. Dumping d. Price gouging ANS: C Dumping refers to the disposal of goods that are surplus to their native market in a foreign market at prices below the prices in the home market or below the costs of manufacturing the goods. REF: 3-7 38. In a compromised market, why do companies undertake dumping as a price strategy? a. To compromise situations where demand for access or accommodations near the event is excessive b. To set prices on certain items near their production costs c. To use price to lure customers into contact with a company d. To enter a market or to sell goods that are no longer wanted by consumers in the home market ANS: D A company undertakes dumping as a price strategy in order to enter a market or to sell goods that are no longer wanted by consumers in the home market. REF: 3-7 39. ____ is the price strategy that sets prices on certain items near their production costs. a. Price and wage control b. Loss leader c. Bait and switch d. Dumping ANS: B Loss leader is another price strategy; it sets prices on certain items near their production costs. REF: 3-7 40. What is the purpose of the loss leader strategy? a. To establish equilibrium where demand for access or accommodations near the event is excessive b. To sell goods that are no longer wanted by consumers in the home market c. To prevent businesses from achieving overly large profits d. To attract customers to the offering company ANS: D The purpose of loss leaders is to attract customers to the offering company. REF: 3-7 41. ____ strategy usually involves advertising items of well-known value at deeply discounted prices. a. Bait and switch b. Dumping c. Frictional loss of efficiency d. Loss leader ANS: A Bait and switch: This strategy usually involves advertising items of well-known value at deeply discounted prices.

REF: 3-7 42. Consider that a consumer electronics retailer may advertise that it is selling big-screen television at a low price. In reality, the retailer has only one such unit available, and it is a floor-damaged unit. When the consumer attempts to purchase the television, the restriction on the purchase is revealed then. Which price strategy did the retailer apply here? a. Bait-and-switch strategy b. Frictional loss strategy c. Loss leader strategy d. Price gouging strategy ANS: A A consumer electronics retailer may advertise that it is selling big-screen televisions at a low price. In reality, the retailer has only one such unit available, and it is a floor-damaged unit. When the consumer attempts to purchase the televisionusually the consumer is on the retailers premisethe restriction is revealed and the bait-and-switch strategy has been executed. REF: 3-7 43. ____ are an item, usually a product, that is given free to induce the customer to buy a product or service of much greater value. a. Premiums b. Discounts c. Incentives d. Piggybacks ANS: A Premiums are an item, usually a product, that is given free to induce the customer to buy a product or service of much greater value. REF: 3-7 44. The term interest rate is defined as the ____ of money. a. Value b. Capacity c. Price d. Profit ANS: C The term interest rate is defined as the price of money. REF: 3-8 45. When the demand for money is ____ and the supply of money is ____, the price of money goes up. a. Low, low b. Low, high c. High, short d. High, high ANS: C When the demand for money is high and the supply of money is short, the price of money (the interest rate) goes up. REF: 3-8

46. Which sectors of the economy are the first to suffer from higher money costs? a. Capital-intensive sectors b. IT-intensive sectors c. Labor-intensive sectors d. Knowledge-intensive sectors ANS: A The capital-intensive sectors of the economy are the first to suffer from higher money costs. REF: 3-8 47. Which of the following is a capital-intensive industry? a. Real estate b. Software c. Retail d. All of the above ANS: A Real estate, steel, and automobile manufacturing are examples of capital-intensive industries. REF: 3-8 48. Price increases can result in high rate of inflation, which when left unchecked can ratchet itself up until the value of the monetary units of the country become virtually worthless. What is the ultimate result of these events on the economy? a. Ratchet effect b. Boom and bust cycle c. Downward spiral effect d. Boomerang effect ANS: B Price increases can result in a high rate of inflation. If the inflation is left unchecked, it will ratchet itself up until the value of the monetary units of the country become virtually worthless. The ultimate result is a boom and bust cycle for the economy. REF: 3-8 49. What is the likely natural correction of unchecked inflations, such as the boom and bust cycle for the economy? a. Market analysis b. Regression c. Inflation spiraling d. Depression ANS: D A depression is the natural correction of such unchecked inflation. REF: 3-8 50. Identify the agency that sets the U.S. monetary policy. a. Federal Reserve Board b. Federal Reserve Bank c. Confederation of Industries d. U.S. Finance Department

ANS: A The government agency that sets U.S. monetary policy is the Federal Reserve Board. REF: 3-8