Final answer:
The problem with using the actual total cost for cost-plus pricing is that it may not be known until after the products are priced and sold. Firms experiment with changes in production to gain insight into profits by observing the effect on marginal revenue and marginal cost, while also considering their cost structure which includes fixed, variable, average, and marginal costs.
Step-by-step explanation:
If a company is trying to implement cost-plus pricing, it must indeed know the total cost before pricing its product. However, the problem with using the actual total cost is that it may not be known until after the products are priced and sold. This approach to pricing can be challenging because firms often lack data needed to draw a complete total cost curve for all levels of production. Instead, firms experiment with production quantities and observe the impact on profits, focusing on how changes in production affect marginal revenue and marginal cost. Additionally, the firm needs to divide its total costs into fixed and variable costs to calculate the average total cost, average variable cost, and marginal cost. These insights, along with the sales and revenue analysis, are critical for making pricing and production decisions.
Moreover, under cost-plus regulation, if producers receive reimbursement for their costs plus a margin, they may have less incentive to keep costs down, which could lead to efficiently inflated costs. Thus, when setting prices, firms must consider not only direct production costs but also the broader market structure and their own long-term cost structure to determine their profit-maximizing strategy.