Transcript Chapter - uwcentre

Chapter 14: Advanced Pricing
Techniques
McGraw-Hill/Irwin
Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.
Advanced Pricing Techniques
• Price discrimination
• Multiple products
• Cost-plus pricing
14-2
Capturing Consumer Surplus
• Uniform pricing
• Charging the same price for every unit of the
product
• Price discrimination
• More profitable alternative to uniform pricing
• Market conditions must allow this practice to
be profitably executed
• Technique of charging different prices for the
same product
• Used to capture consumer surplus (turning
consumer surplus into profit)
14-3
The Trouble with Uniform Pricing
(Figure 14.1)
14-4
Price Discrimination
• Exists when the price-to-marginal cost
ratio differs between two products:
PA
PB

MC A MC B
14-5
Price Discrimination
Three conditions necessary to practice
price discrimination profitably:
1) Firm must possess some degree of market
power
2) A cost-effective means of preventing resale
between lower- and higher-price buyers
(consumer arbitrage) must be implemented
3) Price elasticities must differ between
individual buyers or groups of buyers
14-6
First-Degree (Perfect)
Price Discrimination
• Every unit is sold for the maximum price
each consumer is willing to pay
• Allows the firm to capture entire consumer
surplus
• Difficulties
• Requires precise knowledge about every
buyer’s demand for the good
• Seller must negotiate a different price for every
unit sold to every buyer
14-7
First-Degree (Perfect) Price
Discrimination (Figure 14.2)
14-8
Second-Degree Price Discrimination
• Lower prices are offered for larger
quantities and buyers can self-select the
price by choosing how much to buy
• When the same consumer buys more
than one unit of a good or service at a
time, the marginal value placed on
additional units declines as more units
are consumed
14-9
Second-Degree Price Discrimination
• Two-part pricing
• Charges buyers a fixed access charge (A) to
purchase as many units as they wish for a constant
fee (f) per unit
• Total expenditure (TE) for q units is: TE  A  fq
TE A  fq
Average price (p) is: p 

q
q
A
 f
q
14-10
Second-Degree Price Discrimination
• When consumers have identical
demands, entire consumer surplus can
be captured by:
• Setting f *= MC
• Setting A* = consumer surplus (CS)
• Optimal usage fee when two groups of
buyers have identical demands is the
level for which MRf = MCf
14-11
Inverse Demand Curve for Each of 100
Identical Senior Golfers (Figure 14.3)
14-12
Demand at Northvale Golf Club
(Figure 14.4)
14-13
Second-Degree Price Discrimination
• Declining block pricing
• Offers quantity discounts over successive
discrete blocks of quantities purchased
14-14
Block Pricing with Five Blocks
(Figure 14.5)
14-15
Third-Degree Price Discrimination
• If a firm sells in two markets, 1 & 2
• Allocate output (sales) so MR1 = MR2
• Optimal total output is that for which
MRT = MC
• For profit-maximization, allocate sales of
total output so that
MRT = MC = MR1 = MR2
14-16
Third-Degree Price Discrimination
• Equal-marginal-revenue principle
• Allocating output (sales) so MR1 = MR2
which will maximize total revenue for the
firm (TR1 + TR2)
• More elastic market gets lower price
• Less elastic market gets higher price
14-17
Allocating Sales Between Markets
(Figure 14.6)
14-18
Constructing the Marginal Revenue
Curve (Figure 14.7)
14-19
Profit-Maximization Under Third-Degree
Price Discrimination (Figure 14.8)
14-20
Multiple Products
• Related in consumption
• For two products, X & Y, produce & sell
levels of output for which
MRX = MCX and MRY = MCY
• MRX is a function not only of QX but also
of QY (as is MRY) – conditions must be
satisfied simultaneously
14-21
Bundling Multiple Products
• When price discrimination is not possible,
bundling multiple goods and charging a
single price can be more profitable than
charging individual prices for multiple
goods
• Two conditions for profitable bundling
• Consumers must have different demand
prices for each good in the bundle
• Demand prices must be negatively correlated
across consumer types
14-22
Cost-Plus Pricing
• Common technique for pricing when firms
do not wish to estimate demand & cost
conditions to apply the MR = MC rule for
profit-maximization
• Price charged represents a markup
(margin) over average cost:
P = (1 + m) ATC
Where m is the markup on unit cost
14-23
Cost-Plus Pricing
• Does not generally produce profitmaximizing price
• Fails to incorporate information on demand
& marginal revenue
• Uses average, not marginal, cost
14-24
Practical Problems with
Cost-Plus Pricing (Figure 14.13)
14-25