Reconciling Full-Cost and Marginal-Cost Pricing

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 help firms uncover their optimal price from economic theory. FCP marks up variable cost with the contribution margin per unit, which in equilibrium includes the fixed cost. This requires some knowledge of the firm's equilibrium return, though this is arguably easier a lower informational burden than knowing one's demand curve, which is required for optimal economic pricing. We characterize when FCP can implement the optimal price in a static game, a dynamic game, with multiple products, and under a satisficing objective.