Question

Explain why successful firms that employ markup pricing use fully allocated costs under normal conditions, but typically offer price discounts or accept lower margins during off-peak periods when excess capacity is available.

Answer 1

Firms generally practice this for profitability.

• When an enterprise is at full capacity, completely allocated costs may be reasonable. When facilities are fully occupied during peak hours, expansion is necessary to boost production.
• Only those expenses that truly grow with production, the incremental costs per unit must constitute the basis for establishing pricing if the enterprise has spare capacity, such as during off-peak hours.
• Successful markup pricing enterprises use fully allocated expenses, but during off-peak periods when extra capacity is available, they provide price discounts or accept lower profits.
• In certain cases, production generated during off-peak times is significantly less expensive than production generated during peak times.