Pricing mechanism and methods of price formation in agriculture

The elements of the price mechanism are: ◊ price relations, which emerge between all market entities. Agricultural producers are linked to the immediate consumers of their products, provided they do not require further processing or refinement, with intermediaries, procurement and processing enterprises, with enterprises producing means of production and providing services, and with foreign buyers. All these connections are mediated by prices; ◊ a set (system) of prices — a multitude of prices used in establishing and developing relations between all market entities, which are interconnected and interdependent; ◊ pricing — the process of forming prices for goods, works, and services, which is subject to specific principles, carried out based on special pricing methods, and depends on the type of market the producer enters with their products, as well as other conditions; ◊ state regulation — the activity of the state aimed at stabilizing prices, setting fixed prices, and using indirect influence on prices through taxes, insurance, credit, etc. Along with price self-regulation, state regulation is an essential element of the price mechanism; ◊ pricing policy — a set of measures to influence price in tactical and strategic plans, involving an adequate response to changing market conditions by studying and accounting for a multitude of external and internal factors that influence the price.

The price mechanism in the agro-industrial complex and the agricultural sector should: stimulate food production; contribute to the country's food independence; ensure an optimal combination of free market pricing with state price regulation; create favorable conditions for expanded reproduction at the enterprise through equivalent price exchange between sectors of the agro-industrial complex, stimulation of high-quality crop production, and alignment of prices for agro-industrial products with the purchasing power of enterprises and the population.

Pricing is the most important and complex part of the price mechanism. The pricing methodology is implemented in the following sequence: 1) setting a goal; 2) studying external conditions relative to the enterprise; 3) assessing internal costs; 4) selecting a pricing method; 5) setting the final price. 1. Pricing goals coincide with the goals of the enterprise, its development strategy and tactics. These include: ensuring survival, maximizing current profit, achieving leadership in market share, achieving leadership in product quality, economic growth, limiting potential competition, etc.

Ensuring survival becomes a goal and influences pricing policy if an enterprise faces an alternative: to cease production or to set deliberately low prices for products sold and remain in the production sector and the market, taking appropriate measures to reduce production and sales costs, improve quality, diversify production, obtain loans, retrain personnel, etc.

Maximizing current profit as a pricing goal is achieved when the producer sets a price that allows them to obtain maximum profit under the current market situation and their capabilities. In this case, the enterprise is interested in the results of the short-term period.

By setting the goal of achieving market leadership in the quality of products produced, the enterprise increases costs for purchasing high-quality raw materials (seed, livestock, poultry, feed additives, etc.), new equipment, payment for consultative services and training of workers, and other targeted measures. Demand for high-quality products (characterized by environmental safety, overall nutritional value, etc.) is far from satisfied, and they are purchased at higher prices.

Relative to the enterprise, external conditions include consumer demand, the type of market the enterprise intends to enter with its products, external production participants (suppliers of raw materials, equipment, agro-service), the direction and degree of state regulation, competitors' goods, the prices of those goods, supply, and other conditions.

The price set by the producer will influence demand. The relationship between them is represented in Fig. 14.2, where the demand curve C shows how many goods will be sold on the market during a specific period of time at different prices. As a rule, price and demand are inversely proportional. At a higher price P1, a smaller quantity of goods Q1 is purchased, while a price reduction to the P2 level increases sales volume to Q2. Changes in demand are reflected on the graph by the movement of the demand curve from point X1 to point X2, i.e., the change in the demand curve depends on price, whereas non-price factors cause the curve to shift to the left (curve C2) or to the right (curve C3). Non-price factors are understood as changes in income, the number of consumers, their expectations, changes in tastes and preferences, etc. For example, an increase in population income increases demand, and the demand curve shifts to the right, while with a decrease in income, the demand curve shifts to the left, indicating a reduction in the volume of purchases.

When setting a price, the producer must measure demand, its changes, and consider price elasticity—the degree of demand change under the influence of price fluctuations, considered in relation to both market supply and market demand. The elasticity coefficient is the percentage change in the resultant indicator when the factor indicator changes by 1%:

where ΔPED is the price elasticity of demand (elasticity coefficient); ΔQD is the growth in demand, %; ΔP is the growth in price, %. Growth in demand and growth in price are calculated as the difference between periods.

This market category expresses the market's reaction to changes in a number of factors. A price reduction is advisable if demand is price-elastic. With inelastic demand, when the elasticity coefficient is less than one (PED < 1), a price reduction will not achieve the desired goal, i.e., demand increases by more than 1% for every 1% reduction in price, because demand changes insignificantly even with a significant change in price. Agriculture is a source of essential goods, and for food products, the elasticity coefficient is usually greater than zero and less than one. 3. Estimating one's own costs allows the producer to set a price that fully covers costs and ensures an optimal level of profitability as the ratio of profit included in the price to the cost of production and sale of products. If demand determines the maximum price, the lower price limit is determined by the average total production costs, consisting of fixed and variable costs. With an increase in production volumes, unit costs may initially decrease, but as a certain production volume is reached, average costs begin to increase. Therefore, cost accounting and evaluation of their changes with the growth of production volume (works, services) must be conducted. Next, an analysis of the prices and quality of competitors' goods and their market supply is performed, which allows setting a price range between the minimum limit, dictated by one's own costs, and the maximum, determined by the demand for the given product.

Any commodity producer builds their pricing policy by focusing on the market and its specifics. The nature of pricing, taking into account market types by the degree of competition restriction, is presented in Table 14.1.

T a b l e 14.1. Pricing in different types of markets by the degree of pricing restriction Market Type of pricing Sellers Buyers Price range Pure competition Free, competitive Many One Market Monopolistic Competitive, with elements Many Many Wide range competition of monopoly within the limits of a certain product type Oligopolistic Monopolized, but caused by Many Many Average market mutual competition Market of pure Monopolized One Many Maximum monopoly

A market of pure competition (ideal) is represented by a multitude of sellers and buyers of a similar commodity product, for example, grain, potatoes, vegetables, meat, etc. This is also the market for foreign currencies, securities, agricultural repair services, etc. The situation for pricing here is such that no single seller exerts influence on the level of current market prices and is practically unable to request a price higher than the market price for their goods, because in such a case, buyers will turn to other sellers of similar goods and purchase any quantity of it at the realistically established market price. For this type of market, there are no special problems in developing a pricing policy.

A market of monopolistic competition is characterized by the fact that it is represented by a multitude of sellers and buyers, market products are differentiated, and buying and selling take place at different prices. Significant differences in prices (their wide range) are due to the fact that the totality of homogeneous goods is differentiated by a multitude of qualitative features and properties.

Sellers can offer goods that differ in:

• packaging, wrapping, external design;
• annotations, brand names;
• services for realization and subsequent maintenance;
• advertising and the participation of the producers themselves in the sale of the goods.

As a result, buyers have a wide choice and purchase goods at different prices based on their preferences. Such a market is highly segmented, prices are significantly differentiated by segments, and competition among a large number of sellers (producers) is pronounced. The features of the monopolistic competition market—intense competition, free market entry (no entry barriers and no large expenses required), and product differentiation—necessitate the development of a specific pricing policy by each producer.

An oligopoly market is characterized by a small number of producer-sellers who are highly interdependent; it is difficult for new sellers to enter their market, and oligopolists respond sensitively to each other's pricing policies. An oligopolistic market contains many goods that are both similar and different.

If one of the oligopolists lowers their prices, the others also have to change their strategy. The interdependence of producers is shown in the table:

While maintaining their previous prices, they must offer buyers products of higher quality and better services. Raising prices by one of the oligopolists carries a high risk for them, since competitors may not follow suit and the oligopolist will lose buyers. Such interdependence leads to the establishment of an average price level.

A pure monopoly market is distinguished by the fact that it is represented by a single seller — a monopolist — which may be a state organization, a private regulated monopoly, or a private unregulated monopoly. They structure their pricing policies in different ways:

Basic rules and market constraints of pricing

The pricing of agricultural products directly depends on the market structure and the level of competition. Under a state monopoly, the price is set either at a break-even level to cover total costs or is set higher to limit consumption and production. A private regulated monopoly operates within the framework of state restrictions, allowing for a standard profitability level of 25—30 %. An unregulated private monopolist is capable of dictating any price the market will bear; however, they are constrained by the risk of competitors emerging with a similar product.

In practice, agricultural producers rely on traditional pricing rules. These basic guidelines help to balance cost recovery and the speed of product sales. When calculating minimum, average, and maximum prices, sellers are guided by the following principles:

• The minimum possible price is determined by the cost of production, as selling below costs deprives production of economic sense.
• The maximum price is limited by demand: a cost that is too high hinders sales but is quite acceptable if the product possesses special quality parameters or unique properties.
• The average price level is formed with an eye on competitors' offers and the cost of substitute goods.

Cost-based and market-based methods for calculating product prices

In agriculture, two groups of pricing methods are used: cost-based and market-based. Cost-based methods rely on the cost of production and marketing, while market-based methods are driven by the consumer value of the products and market conditions. The choice of a specific approach depends on the financial stability of the farm and the nature of the demand for the harvest.

The "cost-plus" method is the most common among agricultural enterprises. A fixed markup, necessary for paying taxes, contributions to funds, and the normal operation of the farm, is added to the cost of production and marketing per unit of product. This profitability depends on sales volumes, inventory turnover, and marketing costs. In practice, producers often rely on the profitability level of recent years, adjusting it if necessary.

The second cost-based method is based on break-even analysis and achieving target profit. Costs are preliminarily divided into fixed (not dependent on production volume) and variable (changing along with the volume). Based on this ratio, the contribution margin ratio is found, the break-even sales volume is calculated, and the final price per unit of product is determined. However, most agricultural enterprises use a simplified version of the calculation without separating costs — directly from total costs and desired profit.

The value-based pricing method is considered a market-oriented approach. The primary pricing factor here is the buyer's perception of the product in specific consumption conditions, rather than the seller's costs. The producer focuses primarily on demand, covering costs and generating profit through the market's high valuation of the product.

Market orientation and final price adjustment

When selling commodities that are difficult to differentiate—such as grain, sugar, cement, or fertilizer—it is challenging for a producer to stand out based on product uniqueness. In a market of perfect competition, base prices in a specific price zone are determined by the largest producers. In such a situation, small and medium-sized farms do not dictate their own terms, but instead align with the prevailing level of current market prices.

After choosing an appropriate pricing method, the enterprise proceeds to calculate the specific value of the products. At this stage, the base price is adapted to current market realities and the characteristics of the available goods. The final cost of a batch is always formed taking into account a complex of external constraints and qualitative indicators of the harvest.

When finalizing the price, the producer considers the following factors:

• the level of competition in the price zone;
• current inflationary processes;
• government regulatory measures;
• specifics, quality, and characteristics of the specific product;
• other market conditions that may influence the price.