Transcript The Economic Way of Thinking 10e ©Prentice Hall 2003 Ed Sike

“The Economic Way of Thinking”
10th Edition
by Paul Heyne, Peter Boettke,
and David Prychitko
“Price Searching”
PowerPoint Slides prepared by
Assistant Professor
Paul Harris
Camden County College
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The Economic Way of Thinking 10e
©Prentice Hall 2003
Chapter Outline
I.
II.
III.
IV.
Introduction
The Popular Theory of Price Setting
Introducing Ed Sike
The Basic Rule for Maximizing Net
Revenue
V. The Concept of Marginal Revenue
VI. Why Marginal Revenue Is Less Than
Price
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Chapter Outline
V11.The Basic Rule for Maximizing Net
Revenue
VIII.The Concept of Marginal Revenue
IX. Why Marginal Revenue Is Less Than
Price
X. Setting Marginal Revenue To Equal
Marginal Cost
XI. What About Those Empty Seats?
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Chapter Outline
XII. The Price Discriminator’s Dilemma
XIII.The College As Price Searcher
XIV.Some Strategies For Price
Discrimination
XV. Ed Sike Finds a Way
XVI.Resentment and Rationale
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Chapter Outline
XVII.Lunch and Dinner Prices
XVIII.Cost Plus Markup Reconsidered
XIX.Once Over Lightly
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Introduction
• Firms will produce an additional
product as long as its marginal revenue
is greater than its marginal cost.
• Net Revenue
– Total revenue - total costs
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The Popular
Theory of Price Setting
• A Popular Belief
– Selling price is cost plus markup.
• Questions
– Why choose 25 versus a 50 percent
markup?
– Why will a firm vary its percentage markup
depending upon various factors?
– Why sell below average cost?
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The Popular
Theory of Price Setting
• A Popular Belief
– Selling price is cost plus markup.
• Questions
cost-plus
– Why The
choose
25 versusargument
a 50 percent
markup?
has numerous faults.
– Why will a firm vary its percentage markup
depending upon various factors?
– Why sell below average cost?
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Introducing Ed Sike
Scenario
– Ed Sike is a college sophomore.
– He sells film tickets to earn spending money.
– He sets the price for his tickets.
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Introducing Ed Sike
Ed’s Bills Per Movie
Film rental
Auditorium rental
Operator
Ticket takers
Total
$1,800
250
50
100
$2,200
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Introducing Ed Sike
Scenario
– Ed receives all revenue.
– Auditorium seats 700 people.
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Introducing Ed Sike
Ed’s Demand Schedule
Price
$3.00
2.50
Quantity
Demanded
700
750
Total
Revenue
$2,100
1750
Net
Revenue
-$100
-$450
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Introducing Ed Sike
D
7
Price Per Ticket
6
5
4
3
2
1
0 100 200 300 400 500 600 700 800 900
Number of Tickets
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Introducing Ed Sike
Scenario
– The student association will subsidize the
films if they lose money.
– Ed is expected to earn as much net revenue as
possible.
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The Basic Rule for
Maximizing Net Revenue
Set the Price so that
only those units
whose marginal
revenue
is greater than
marginal Costs.
Marginal costs is the
addition to total cost
from selling an
additional unit.
Marginal revenue is the
addition to total
revenue from selling
one more unit.
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The Concept of
Marginal Revenue
Ed’s Demand Schedule
Price
$7
6
5
4
$3
Quantity
Demanded
300
400
500
600
700
Total
Revenue
Net
Revenue
$2,100
2,400
2,500
2,400
$2,100
-$100
200
300
200
-100
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The Concept of
Marginal Revenue
Marginal Revenue
The additional revenue expected from
an action under consideration.
Ed’s marginal revenue is zero.
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The Economic Way of Thinking 10e
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The Concept of
Marginal Revenue
Ed’s Demand Schedule
Price
$7
6
5
4
$3
Quantity
Demanded
300
400
500
600
700
Total
Revenue
Net
Revenue
$2,100
2,400
2,500
2,400
$2,100
-$100
200
300
200
-100
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The Concept of
Marginal Revenue
• Question
– Why is profit maximized where marginal
revenue equals marginal cost?
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Why Marginal Revenue
Is Less Than Price
Marginal revenue < Price
Why?
In order to increase sales, Ed must lower
the price on the additional ticket and the
ones that would have been sold at a
higher price.
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Why Marginal Revenue
Is Less Than Price
Marginal revenue
The difference between the revenue gained
from additional quantity and the revenue
lost from lowering price on the previous
quantity
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Why Marginal Revenue
Is Less Than Price
P
A
Lost
B
Gained
D
Q
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Why Marginal Revenue
Is Less Than Price
P
Additions to
net revenue
MC
Subtractions
from net
revenue
MR
Q
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Why Marginal Revenue
Is Less Than Price
• Questions
– What would Ed have to do to sell 550
tickets instead of 500?
– How would this impact his marginal
revenue?
– Is it a correct pricing decision?
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Why Marginal Revenue
Is Less Than Price
P
MR
0 100 200 300 400 500 600 700 800 900
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Q
25
Setting Marginal Revenue To
Equal Marginal Cost
Question
What would happen if the distributor
changed the rental fee to $800 +
$2/ticket sold?
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Setting Marginal Revenue To
Equal Marginal Cost
P
What is Ed’s
net revenue now?
7
6
5
4
3
2
Marginal cost
D
1
MR
0 100 200 300 400 500 600 700 800 900
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Q
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What About
Those Empty Seats?
• Questions
– Aren’t seats going to waste?
– Why doesn’t Ed lower the price on the
empty seats?
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The Price
Discriminator’s Dilemma
• Question
– When should Ed leave seats empty?
• Answer
– If the cost of discriminating among
potential ticket buyers is greater than the
additional revenue gained through
discrimination
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The Price
Discriminator’s Dilemma
Question
What if Ed offered to sell the empty seats for
$3 to anyone unwilling to pay more?
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The College As a Price Searcher
• Questions
– Why do colleges continually ask for
donations to cover costs not paid for by
tuition?
– Why do these colleges give scholarships
to needy students?
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Demand Curve for Enrollment
at Ivy College
Annual Tuition/Student
6,000
5,000
Assume MC = 0
4,000
3,000
2,000
1,000
MR
D
0
0 1,000 2,000 3,000 4,000 5,000 6,000
Students enrolling (per year)
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Q
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The College As a Price Searcher
Questions
How could Ivy charge $6,000 and give
each student a scholarship equal to the
difference between $6,000 and what the
student is willing to pay?
How does the school determine what
each student is willing to pay?
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The College As a Price Searcher
Solutions
Willingness to pay is correlated with
wealth.
Scholarships are available to those who
fill out some forms.
Ivy could discriminate based on wealth
to increase revenue.
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The College As a Price Searcher
P
6,000
Scholarships
Revenue has
increased from
$9m to $18m.
Tuition
Paid
enrolled
The Economic Way of Thinking 10e
D
Q
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Some Strategies for
Price Discrimination
Grocery Coupons
Discounts for:
Children
Students
Senior citizens
Airfare Prices
Business
traveler
Vacationer
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Some Strategies for
Price Discrimination
P
P
Business
Traveler
Vacation
Traveler
D
D
Q
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Ed Sike Finds A Way
Questions
Could Ed increase revenue by
charging different groups of
customers different prices?
Should students or teachers pay the
higher price?
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Ed Sike Finds A Way
7
Ds
Dfaculty
Price Per Ticket
6
5
4
3
MRfaculty
2
1
MRs
0 100 200 300 400 500 600 700 800 900
Number of Tickets
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Resentment and Rationale
Firms must justify price discrimination.
Conditions Necessary for Price
Discrimination
Distinguish buyers with different price
elasticities
Prevent low-price buyers from reselling to
high-price buyers
Control resentment
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Resentment and Rationale
• Question
– Why would a ticket from New York to
Chicago cost more than a ticket from
New York to Los Angeles?
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Resentment and Rationale
P
DChicago
DLA
Q
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Lunch and Dinner Prices
• Question
– Why are lunch prices more
expensive than dinner prices?
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Lunch and Dinner Prices
• Answer
– Lunch customers are more responsive
to prices.
• They eat out more.
• The meal makes up a large share of
the event’s cost (no sitter, movie,
etc.).
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Cost Plus Markup Reconsidered
• Price Searchers:
1) Estimate marginal cost and marginal
revenue.
2) Determine the appropriate level of
output.
3) Set their prices so that they can just
manage to sell the output produced. `
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Cost Plus Markup Reconsidered
• Cost-Plus Markup
– A good place to start
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Once Over Lightly
Price searchers are looking for pricing
structures that will enable them to sell
all units for which MR>MC.
A crucial factor for a price searcher is
the ability or inability to discriminate.
The crucial rule for price searching is to
set MR= to MC.
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Next. Chapter 11,
“ Competition
and
Government
Policy”
End of Chapter 10
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