Which of the following best describes target profit pricing?

• A. Setting the price of a product so that the firm achieves a specific desired profit level
• B. Setting the price to maximize total revenue regardless of costs
• C. Setting the price equal to the marginal cost of production
• D. Setting the price based on the average market price of competitors

Answer: (A)

Verified step by step guidance

1. Understand the concept of target profit pricing: it involves setting the price of a product to ensure the firm achieves a specific desired profit level.
2. Recall that profit is defined as total revenue minus total cost, where total revenue is price times quantity (\(TR = P \times Q\)) and total cost includes both fixed and variable costs (\(TC = FC + VC\)).
3. Recognize that target profit pricing requires determining the price (\(P\)) that satisfies the equation for target profit (\(\pi\)): \(\pi = TR - TC\) or \(\pi = P \times Q - TC\).
4. Rearrange the equation to solve for the price: \(P = \frac{\pi + TC}{Q}\), where \(\pi\) is the target profit, \(TC\) is total cost, and \(Q\) is the quantity sold.
5. Compare this approach to other pricing strategies such as pricing to maximize revenue, pricing at marginal cost, or pricing based on competitors, and identify that target profit pricing specifically focuses on achieving a predetermined profit level.