Reconciling Full-Cost and Marginal-Cost Pricing

Abstract

ABSTRACT Despite the clear prescription from economic theory that a firm should set price based only on variable costs, firms routinely factor fixed costs into pricing decisions. We show that full-cost pricing (FCP) can achieve the optimal price. FCP marks up variable cost with the contribution margin per unit, which, in equilibrium, includes the fixed cost. FCP converges to the optimal price when the firm can estimate its equilibrium income. We compare FCP to alternative pricing algorithms that require less information, but converge to optimal price under more narrow conditions than FCP.