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Chapter 15: Pricing Strategy
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
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Chapter 15: Pricing Strategy
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
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CHAPTER
15
Chapter 15: Pricing Strategy
Pricing Strategy
Why does Disney
charge so many
different prices for
the same product?
Prepared by:
Fernando Quijano
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
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CHAPTER
15
Pricing Strategy
Chapter Outline and
Learning Objectives
15.1 Pricing Strategy, the Law of One
Price, and Arbitrage
Define the law of one price and
explain the role of arbitrage.
Chapter 15: Pricing Strategy
15.2 Price Discrimination: Charging
Different Prices for the Same
Product
Explain how a firm can increase its
profits through price discrimination.
15.3 Other Pricing Strategies
Explain how some firms increase their
profits through the use of odd pricing,
cost-plus pricing, and two-part tariffs.
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Pricing Strategy, The Law of One
Price, and Arbitrage
15.1 LEARNING OBJECTIVE
Define the law of one price and
explain the role of arbitrage.
Arbitrage
Chapter 15: Pricing Strategy
Transactions costs The costs
in time and other resources that
parties incur in the process of
agreeing to and carrying out an
exchange of goods or services.
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15.1 LEARNING OBJECTIVE
Solved Problem
15-1
Define the law of one price and
explain the role of arbitrage.
Is Arbitrage Just a Rip-off?
Does eBay serve a useful economic purpose?
Economists would say that it does.
Chapter 15: Pricing Strategy
It is easy to sell goods on eBay, so over time,
competition should cause the difference between the
prices on eBay and the prices charged elsewhere to
shrink .
YOUR TURN: For more practice, do related problems 1.5 and 1.6 at the end of
this chapter.
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Pricing Strategy, The Law of One
Price, and Arbitrage
15.1 LEARNING OBJECTIVE
Define the law of one price and
explain the role of arbitrage.
Why Don’t All Firms Charge the Same Price?
Table 15-1
Which Internet Bookseller
Would You Buy From?
PRODUCT: DAN BROWN’S THE LOST SYMBOL
COMPANY
PRICE
Amazon.com
$14.83
14.83
WaitForeverForYourOrder.com
13.50
JustStartedinBusinessLastWednesday.com
13.25
Chapter 15: Pricing Strategy
BarnesandNoble.com
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Price Discrimination: Charging
Different Prices for the Same Product
15.2 LEARNING OBJECTIVE
Explain how a firm can increase its
profits through price discrimination.
Chapter 15: Pricing Strategy
Price discrimination Charging
different prices to different customers
for the same product when the price
differences are not due to differences
in cost.
Don’t Let This Happen to YOU!
Don’t Confuse Price Discrimination with Other Types of Discrimination
YOUR TURN: Test your understanding by doing related problem 2.18 at the end
of this chapter.
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Price Discrimination: Charging
Different Prices for the Same Product
15.2 LEARNING OBJECTIVE
Explain how a firm can increase its
profits through price discrimination.
The Requirements for Successful Price Discrimination
Chapter 15: Pricing Strategy
A successful strategy of price discrimination has
three requirements:
1.
A firm must possess market power.
2.
Some consumers must have a greater willingness
to pay for the product than other consumers, and
the firm must be able to know what prices customers
are willing to pay.
3.
The firm must be able to divide up—or segment—the
market for the product so that consumers who buy the
product at a low price are not able to resell
it at a high price. In other words, price discrimination
will not work if arbitrage is possible.
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Price Discrimination: Charging
Different Prices for the Same Product
15.2 LEARNING OBJECTIVE
Explain how a firm can increase its
profits through price discrimination.
Chapter 15: Pricing Strategy
The Requirements for Successful Price Discrimination
FIGURE 15-1
Price Discrimination by a Movie Theater
Fewer people want to go to the movies in the afternoon than in the evening. In panel (a), the profit-maximizing
price for a ticket to an afternoon showing is $7.25.
Charging this same price for evening showings would not be profit maximizing, as panel (b) shows.
At a price of $7.25, 850 tickets would be sold to evening showings, which is more than the profit-maximizing
number of 625 tickets. To maximize profits, the theater should charge $9.75 for tickets to evening showings.
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15.2 LEARNING OBJECTIVE
Solved Problem
15-2
Explain how a firm can increase its
profits through price discrimination.
Chapter 15: Pricing Strategy
How Apple Uses Price Discrimination to Increase Profits
if Apple charges $1,399 in the general public segment of the market, shown in panel (b), it would
sell 32,500 computers, which is more than the profit-maximizing quantity. By charging $1,499 to
the general public, Apple will sell 30,500 computers, the profit-maximizing quantity.
YOUR TURN: For more practice, do related problem 2.12 at the end of this
chapter.
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Price Discrimination: Charging
Different Prices for the Same Product
15.2 LEARNING OBJECTIVE
Explain how a firm can increase its
profits through price discrimination.
Chapter 15: Pricing Strategy
Airlines: The Kings of Price Discrimination
FIGURE 15-2
33 Customers and 27 Different Prices
To fill as many seats on a flight as possible, airlines charge many different ticket prices. The 33 passengers on this
United Airlines flight from Chicago to Los Angeles paid 27 different prices for their tickets, including one passenger
who used frequent flyer miles to obtain a free ticket. The first number in the figure is the price paid for the ticket; the
second number is the number of days in advance that the ticket was purchased.
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Making
the
Connection
15.2 LEARNING OBJECTIVE
How Colleges Use
Yield Management
Explain how a firm can increase its
profits through price discrimination.
Chapter 15: Pricing Strategy
When colleges use yield management
techniques, they increase financial aid
offers to students who are likely to be
more price sensitive, and they reduce
financial aid offers to students who are
likely to be less price sensitive.
Some colleges use yield
management techniques
to determine financial aid.
YOUR TURN: Test your understanding by doing related problem 2.14 at the end
of this chapter.
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Price Discrimination: Charging
Different Prices for the Same Product
15.2 LEARNING OBJECTIVE
Explain how a firm can increase its
profits through price discrimination.
Chapter 15: Pricing Strategy
Perfect Price Discrimination
FIGURE 15-3
Perfect Price Discrimination
Panel (a) shows the case of a monopolist who cannot
practice price discrimination and, therefore, can charge
only a single price for its product. Because the monopolist
stops production at a level of output where price is above
marginal cost, there is a deadweight loss.
In panel (b), the monopolist is able to practice perfect
price discrimination by charging a different price to
each consumer. The result is to convert both the
consumer surplus and the deadweight loss from panel
(a) into profit.
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Price Discrimination: Charging
Different Prices for the Same Product
15.2 LEARNING OBJECTIVE
Explain how a firm can increase its
profits through price discrimination.
Chapter 15: Pricing Strategy
Price Discrimination across Time
FIGURE 15-4
Price Discrimination across Time
In panel (a), with a marginal cost of $1.50 per copy for a
hardcover, the profit-maximizing level of output is 500,000
copies, which can be sold at a price of $27.95.
In panel (b), the more elastic demand of casual
readers and the slightly lower marginal cost result in a
profit-maximizing output of 1,000,000 for the
paperback edition, which can be sold at a price of
$9.99.
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Price Discrimination: Charging
Different Prices for the Same Product
15.2 LEARNING OBJECTIVE
Explain how a firm can increase its
profits through price discrimination.
Can Price Discrimination Be Illegal?
Chapter 15: Pricing Strategy
In 1936, Congress passed the Robinson–
Patman Act, which outlawed price
discrimination that reduced competition
and which also contained language that
could be interpreted as making illegal all
price discrimination not based on
differences in cost.
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Making
the
Connection
15.2 LEARNING OBJECTIVE
Price Discrimination with
a Twist at Netflix
Explain how a firm can increase its
profits through price discrimination.
Chapter 15: Pricing Strategy
Price discrimination can also
involve charging the same price for
goods or services of different
quality.
Netflix subscribers who rent the
fewest movies per month have the
best chance of receiving the latest
releases.
Why does renting only a few movies
get you better service with Netflix?
YOUR TURN: Test your understanding by doing related problem 2.17 at the end
of this chapter.
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15.3 LEARNING OBJECTIVE
Other Pricing Strategies
Explain how some firms increase their
profits through the use of odd pricing,
cost-plus pricing, and two-part tariffs.
Odd Pricing: Why Is the Price $2.99 Instead of $3.00?
Many firms use what is called odd pricing—for
example, charging $4.95 instead of $5.00, or
$199 instead of $200.
Do consumers have an illusion that a price of
$9.99 is significantly cheaper than $10.00?
Chapter 15: Pricing Strategy
There is some evidence that using odd prices
makes economic sense.
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15.3 LEARNING OBJECTIVE
Other Pricing Strategies
Explain how some firms increase their
profits through the use of odd pricing,
cost-plus pricing, and two-part tariffs.
Why Do Some Firms Use Cost-Plus Pricing?
Economists conclude that using cost-plus pricing
may be the best way to determine the optimal
price in two situations:
Chapter 15: Pricing Strategy
1. When marginal cost and average cost are
roughly equal
2. When the firm has difficulty estimating its
demand curve
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Making
the
Connection
15.3 LEARNING OBJECTIVE
Cost-Plus Pricing in the
Publishing Industry
Explain how some firms increase their
profits through the use of odd pricing,
cost-plus pricing, and two-part tariffs.
PLANT COSTS
Typesetting
Other plant costs
$3,500
2,000
Printing
Paper
Binding
$5,750
6,250
5,000
MANUFACTURING COSTS
Chapter 15: Pricing Strategy
TOTAL PRODUCTION COST
$22,500
Most publishers arrive at a price for a book by applying a markup to
their production costs, which are usually divided into plant costs and
manufacturing costs.
YOUR TURN: Test your understanding by doing related problem 3.8 at the end of
this chapter.
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15.3 LEARNING OBJECTIVE
Other Pricing Strategies
Explain how some firms increase their
profits through the use of odd pricing,
cost-plus pricing, and two-part tariffs.
Why Do Some Firms Use Two-Part Tariffs?
Chapter 15: Pricing Strategy
Two-part tariff A situation in
which consumers pay one price
(or tariff) for the right to buy as
much of a related good as they
want at a second price.
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15.3 LEARNING OBJECTIVE
Other Pricing Strategies
Explain how some firms increase their
profits through the use of odd pricing,
cost-plus pricing, and two-part tariffs.
Chapter 15: Pricing Strategy
Why Do Some Firms Use Two-Part Tariffs?
FIGURE 15-5
A Two-Part Tariff at Disney World
In panel (a), Disney charges the monopoly price of $26
per ride ticket and sells 20,000 ride tickets. Its profit from
ride tickets is shown by the area of the light-green
rectangle, B, $480,000.
In panel (b), Disney charges the perfectly competitive
price of $2, which results in a quantity of 40,000 ride
tickets sold. At the lower ride ticket price, Disney can
charge a higher price for admission tickets, which will
increase its total profits.
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
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15.3 LEARNING OBJECTIVE
Other Pricing Strategies
Explain how some firms increase their
profits through the use of odd pricing,
cost-plus pricing, and two-part tariffs.
Why Do Some Firms Use Two-Part Tariffs?
Table 15-2
Disney’s Profits per Day from
Different Pricing Strategies
MONOPOLY PRICE
FOR RIDES
PROFITS FROM ADMISSION
TICKETS
COMPETITIVE PRICE
FOR RIDES
$960,000
PROFITS FROM RIDE TICKETS
480,000
0
TOTAL PROFIT
720,000
960,000
Chapter 15: Pricing Strategy
$240,000
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15.3 LEARNING OBJECTIVE
Other Pricing Strategies
Explain how some firms increase their
profits through the use of odd pricing,
cost-plus pricing, and two-part tariffs.
Why Do Some Firms Use Two-Part Tariffs?
It is important to note the following about the outcome of a firm
using an optimal two-part tariff:
1. Because price equals marginal cost at the level of
output supplied, the outcome is economically
efficient.
Chapter 15: Pricing Strategy
2. All consumer surplus is transformed into profit.
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
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AN INSIDE
LOOK
>> Paying for the Right to Pay to See
“America’s Team”
Chapter 15: Pricing Strategy
An NFL team owner can use a two-part tariff to increase profits.
The profit-maximizing
monopoly price for a season
ticket is $2,000. This assumes
that tickets to individual games
are sold for $200 each.
If the team owner knew the
maximum each season ticket
buyer was willing to pay, he
could charge a PSL fee that
would result in a total amount
paid by all season ticket buyers
equal to area A—the total
consumer surplus.
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KEY TERMS
Chapter 15: Pricing Strategy
Price discrimination
Transactions costs
Two-part tariff
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
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