Cyclical Pricing refers to appropriate pricing strategy at different stages of Business Cycle (discussed in Chapter 19). Every Business Cycle consists of four phases: Recession, Depression, Recovery and Prosperity. Contraction comprises of the first two phases and the last two phases constitute expansion.
The recession phase is basically the downturn phase of an economy, which is characterized by decline in aggregate demand, wage rate etc. During recovery, some macroeconomic variables including these above-mentioned variables change, following the change in GDP.
Business Cycles cause decline in aggregate economic activity, which results in fall in purchasing power of the consumers. As a result of this, it is argued that strategies are to be revised and appropriate pricing policies need to be adopted depending on the phase of Business Cycle the economy passes through.
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There lies a difference in opinion regarding appropriate pricing policy during various phases of Business Cycle. Experts are polarized in terms of appropriateness of pricing policy. Here both the suggested policies are presented:
(1) Rigid Pricing
(2) Flexible Pricing
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Let us examine justifications of both the options one by one:
(1) Rigid Pricing:
During contraction and depression of an economy, purchasing power of customers decline. But so far as necessity items are concerned, customers do not have to find any choice but to purchase these products irrespective of the condition of the economy. Thus, adjustment of price for different stages of Business Cycle cannot show better results.
For the expensive durable goods, which are not so necessary, deliberate reduction in price, the advocates of this pricing strategy believes, will cause postponement of purchase decision by prospective buyers with an expectation of further decline in price. So, adjustment in price depending on phases of Business cycle in unlikely to help the firms.
For the capital goods (machines used to manufacture other machines), price reduction during contraction cannot improve business performance, since business of end product shows lackluster. Thus, if price is reduced during contraction, it is unlikely that any improvement in business will be experienced. This logic favours Rigid Pricing, which does not allow any adjustment of price depending on different stages of business.
(2) Flexible Pricing:
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Flexible Pricing, as a concept, is just opposite to Rigid Pricing. The justification of Flexible Pricing is easier to understand if we consider the case of agricultural products. Since supply of agricultural products is inelastic, (i.e., the supply curve is a vertical straight line), leftward shift in the demand curve of these products reduces equilibrium price. Only a policy to recourse to Flexible Pricing, and by linking it to the general price index, loss arising out of unsold products will have to be borne by the producers. This adjustment in price is referred to as “General Price Index Pricing”.
For industrial products, the argument is different. Higher profit of firms can be generated by securing more customers through reduction in price. That is, reduced per unit profit can more than offset increase in quantity, provided price elasticity of demand for the product is high. There can be another possibility.
If a new type of car is invented, where a cheaper fuel can be used (say, bio-diesel), then that type of car can be sold at a high price (assuming that there is a huge price gap between bio-diesel and ordinary diesel) even during contraction phase of Business Cycle. Since this adjustment of price is totally dependent on nature of demand, it is referred to as “Product Demand Linked Pricing”.