Why do high production costs have any impact on what pricing should be? 

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takayama729 eNotes educator | Certified Educator

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Production costs do directly influence pricing decisions. Contribution margin is the selling price per unit minus the variable cost per unit (Formula: C = P - V where C is the unit contribution margin, P is the unit revenue (Price), and V is the unit variable cost). As a result, to increase a product's contribution margin, a firm has two levers, Price and Variable Costs. If a firm has high production costs, to maintain the desired level of profitability, the firm must instate a commensurate increase in the product's unit price. However, increasing a product's unit price may have a negative impact on the product's sales, in essence erasing any of the required additional revenue from the price increase. As a result, while production costs are a component of pricing decisions, they are not the only factor.

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pohnpei397 eNotes educator | Certified Educator

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High production costs affect prices because firms must have prices that are high enough to cover the costs of production.  If a firm charges a price that is lower than its costs of production (technically, a price that is lower than its average variable costs) it will go out of business.  This is because it will be losing more money by making the product than it would if it simply shut down. 

Of course, firms cannot simply raise their prices to offset high production costs if other competitors can produce more cheaply or if customers will not pay the higher price.  However, high production costs do affect prices since firms will either have to raise prices high enough to cover their costs or go out of business.

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