The cost of goods was $1.00. The cost of labor to manufacture the item was $0.50. The sales price of the item was $5.00. The item always provides a good profit for the stores selling it. Which method of reasoning has been used here and why do you think so?

Expert Answers

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When deciding the price at which to sell a product, one should consider multiple questions. The first, and most basic, is: Will you make your money back? In this case, the answer is a resounding yes! If your total cost to produce the item is $1.50 (one dollar for materials, and 50 cents for manufacturing), and you sell each item for five dollars, that is a net profit of $3.50 per item sold. That is an enormous profit margin. According to the site referenced below, Price Intelligently, you have chosen to use a method of reasoning called Cost-Plus Strategy. Essentially, as long as you make your money back, and some profit besides, you have accomplished the goal of Cost-Plus pricing.

However, there are some significant downfalls to Cost-Plus pricing. First, there is little flexibility in this pricing model, so you have to have enough extra in order to cover any unforeseen costs that may arise. More importantly, customers do not care about the company's profit. The customer will always choose to buy the item that seems to them to be the best value, compared to other similar items. Therefore, the seller should consider whether the $5 item is selling as expected. A profit margin is only as good as the number of sales, so attracting and keeping customers is the most important factor to consider when pricing an item.

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