Transcript Pricing Strategies for the Firms

Week 10
Markup Pricing
• Profit Maximization and Markup Pricing
Price Discrimination
• Definition
• Theoretical Models
– First Degree
– Second Degree
– Third Degree
• Price Discrimination Strategies
– Personalized Pricing
– Group Pricing
– Versioning
– Bundling
– Coupon and Sales
– Two-Part Pricing
• Macroeconomics and Pricing Policies
Markup Pricing
Cost-plus Pricing
Calculating the price of a product by determining the
average cost of producing the product and then setting the
price a given percentage above that cost.
P = average total cost + (m)(average total cost)
= (1 + m) average variable cost
where m is the markup on unit cost.
Problems with cost-plus pricing
• calculation of average variable cost
• size of the markup
Considers only cost of production and does not incorporate
information on demand and consumer preferences.
Thus, is not a profit-maximizing pricing strategy.
1 Manager assumes that
firms operates at 5,000
unit, i.e. cost per unit
is $20. A
2
Since standard markup employed is 50%; then manager
charges $30(=1.5x$20). Profit margin expected $10 (=$30-$20)
per unit. If able to sell 5,000 units, then would earn $50,000
(=$10x5,000)
$
3
Given actual D, only 4,000 units are sold at $30
per unit. C
40
4 Actual profit is $48,000
(= ($30-$18)4,000
SMC
C
30
D
20
ATC
A
$18
MR
3,000
4,000
5,000
Q
Observed
Markup differs from one product to another
Markup will probably change on a given product from time to time.
Differs according to such factors as the degree of competitiveness in the
market and the price elasticity of demand.
Lower markup where competition is intense.
Lower markup when price is more elastic.
The Relationship between Marginal Revenue
and
the Price Elasticity of Demand
Value of Elasticity
Value of
Marginal
Revenue
Numerical Example
MR > 0
eP = -2;
MR < 0
eP = -1/2;
MR = 0
eP = -1;
The Profit-Maximizing Rule for Markup Pricing
MR = MC
Optimal markup:
where,
m = markup and
ep = price elasticity of demand
Optimal markup:
No ep < 1 is included since MR is –ve then and
profit max level of output never occurs where
MR is –ve.
Elasticity
Calculation
Markup
-2.0
m = -[1/(1 - 2)] = +1.00
1.00 or 100%
-5.0
m = -[1/(1 – 5)] = +.25
0.25 or 25%
-11.0
m = -[1/(1 - 11)] = +0.10
0.10 or 10%
∞
m = -[1/(1 - ∞)] = 0
0.00 (no markup)
The less elastic is the demand curve, the larger will be the markup.
What types of goods have lesser elasticity? What types of markets?
Price Discrimination
Price discrimination is the practice of charging different prices to
various groups of customers that are not based on differences in the
costs of production.
Why Do Companies Price Discriminate?
$
100
2
60
Some customers are willing to pay more than $60.
Hence possible additional profit from consumer surplus; $800
(=1/2x40($100-$60))
1
Price as a price controller; $60.
Hence, profit; $1,600 (=$60-$20(40))
Some customers are willing to pay if
3 $20<P<$60.
Hence possible additional profit from
consumer surplus; $800 (=1/2x40($60-$20))
20
MC
40 50
80
100
Rounds of golf
By charging such customers a different price, the company could profitably sell to a
much larger customer base.
Conditions for price discrimination
1.
Firms must possess some degree of monopoly or market power
 that enables them to charge a price in excess of the costs of
production
2.
Firm can prevent or limit arbitrage
 the markets in which the products are sold must by
separated (no resale between markets)
 products with identical costs are sold in different markets
at different prices
3. Consumers differ in their demand for a given good or service
 The demand curves in the market must have different
elasticities
 Firms must be able to separate customers into different groups
that have varying price elasticities of demand
Price Discrimination
First Degree
 seller can identify where each consumer lies on the
demand curve and charges each consumer the highest
price the consumer is willing to pay
 price varies by customer's willingness or ability to pay
 allows the seller to extract the greatest amount of profits
 requires a considerable amount of information
$
100
2
60
Some customers are willing to pay more than $60.
Hence possible additional profit from consumer surplus; $800
[=1/2x40($100-$60)
1
Price as a price controller or monopolist; $60.
Hence, profit; $1,600 (=$60-$20(40)
3
Some customers are willing to pay if
$20<P<$60.
Hence possible additional profit from
consumer surplus; $800 [=1/2x40($60-$20)
20
MC
Rounds of golf
40 50
80
100
New TR with 1st Degree; $1,600+$800+$800=$3,200.
An example:
Medicine
Extra
strength
Regular




200 mg of active ingredient
3 times daily
18 pills in a box
$9.99 each box




300 mg of active ingredient
2 times daily
12 pills in a box
$15.99 each box
Personalized pricing strategy where companies set different prices for
customers based on the personal information they have about the customers.
Businesses recognize that buyers value any given product or service differently.
Wealthier consumers often pay higher prices for services than less-affluent
people do.
The most common examples of such pricing practices occur in medical and
legal services.
Colleges and universities also practice income-based pricing by tailoring
financial aid packages to each student's ability to pay.
The online retailer, Amazon.com, only asks for your name when your register
on the website, but it carefully tracks what you have purchased and collects
personal information about your buying habits.
Amazon.com uses this information in different ways. Once you make a
purchase, you are presented with recommendations based on previous
purchases.
Personalisation helps them identify your interests and your willingness to pay.
When it was discovered that Amazon.com was selling the same digital video
disc (DVD) at different prices to different customers, Amazon.com claimed it
was only "price testing"
Websites
Websites like MP3.com, a digital music site, and NYTimes.com, the
online face of The New York Times, use cookies that store
information about the identity of users on their computers so that
they can identify these users when they visit.
These sites can track all the things users view online: the
information they look up, the games they play and their purchases.
Price Discrimination
Second Degree
 price varies according to quantity sold
– Larger quantities are available at a lower unit price.
 differential prices charged by blocks of services
 requires metering of services consumed by buyers
It is also called indirect price discrimination: a setting where a menu
of options is offered to all and customers choose which option is
best for them.
$
1
Customers pay different prices depending on the quantity
purchased.
A
2
First degree revenue = 0ADQ1
Second degree; able to sell at 3 block of price;
1. P3; 2. P2; and 3. P3.
2. Thus revenue = 0P3BQ3+Q3ECQ2+Q2FDQ1
3
P3
P2
B
E
C
F
D
P1
0
Q3
Q2
Q1
MC
Q
Price Discrimination
Third Degree
 price varies by attributes of customers
 A pricing strategy under which firms with market power separate
markets according to the price elasticity of demand and charge a
higher price (relative to cost) in the market with the more inelastic
demand
 customers are segregated into different markets and charged
different prices in each
 segmentation can be based on any characteristic such as age,
location, gender, income, etc
Group Pricing
Price Discrimination
Third Degree
Income
Protease inhibitors and other AIDs drugs in Norway and Africa.
Should be
But
Norway; higher income thus their demand is more inelastic.
Africa: price should be lower becoz demand is more price-sensitive.
Norway: lower price though demand is more in Africa.
Why?
Price Discrimination
$
Third Degree
$
Market A
$
Market B
Total Market
MCT
P
DT
DB
DA
MRA
MRB
Q
MRT
Q
QT
• assume the firm operates in two markets, A and B
• the demand in market A is less elastic than the demand in market B
• the entire market faced by the firm is described by the horizontal sum of the
demand and marginal revenue curves …
Q
Price Discrimination
$
Third Degree
$
Market A
$
Market B
Total Market
MCT
P
DT
DB
DA
MRA
MRB
Q
MRT
Q
QT
• the firm finds the total amount to produce by equating the marginal revenue
and marginal cost in the market as a whole: QT
• if the firm were forced to charge a uniform price, it would find the price by
examining the aggregate demand DT at the output level QT
• the firm can increase its profits by charging a different price in each market …
Q
Price Discrimination
$
Third Degree
Market A
$
Market B
$
Total Market
MCT
P
DT
DB
DA
MRA
QA
MRB
Q
QB
MRT
Q
QT
• in order to find the optimum price to charge in each market, draw a horizontal
line back from the MRT/MCT intersection
• where this line intersects each submarket’s MR curve determines the amount
that should be sold in each market: QA and QB
• these quantities are then used to determine the price in each market using the
demand curves DA and DB
Q
A monopolist sells in two geographically divided markets, A
and B. Marginal cost is constant at $50 in both markets.
Demand and marginal revenue in each market are as
follows:
QA = 900 – 2PA
MRA = 450 - QA
QB = 700 – PB
MRB = 700 - 2QB
a. Find the profit-maximizing price and quantity in each
market.
b. In which market is demand more elastic?
Price Discrimination
Versioning
 Offering different versions of a product to different
groups of customers at various prices, with the
versions designed to meet the needs of the specific
groups.
 Book publishers have long used versioning when they
publish a hardcover edition of a book and then wait a
number of months before the cheaper paperback
edition is released.
Movie studios sometimes release special editions of movies. For instance,
the DVD version of Shakespeare in Loveincludes additional features such as
director and actor interviews, deleted scenes, a wide-screen edition, and
closed captioning for US$32.99, whereas the VHS version has no bonus
materials and costs $14.99.
Intuit, a software company, offers TurboTax for US$29.95 and TurboTax
Deluxe, which includes additional features including "more money saving
advice" and Internal Revenue Service publications for $39.95.
Price Discrimination
Bundling
 Bundling involves selling multiple products as a bundle
where the price of the bundle is less than the sum of the
prices of the individual products or where the bundle
reduces the dispersion in willingness to pay.
 Microsoft Office bundles its products together, but also sells
them separately.
The next time you walk into your favourite electronics store and inquire about
the price of a personal computer, you will notice that you can buy a computer
(CPU), a monitor and a printer in one package. In addition, these packages also
commonly include certain software programs and perhaps a DVD player, a
compact disc (CD) writer and free access to the Internet for a limited time.
31
Price Discrimination
Coupons and Sales
 Using coupons and sales to lower the price of the
product for those customers willing to incur the costs
of using these devices as opposed to lowering the price
of the product for all customers.
 Those individuals who clip coupons or watch newspaper
advertisements for sales are more price sensitive than consumers who
do not engage in these activities, and they are also willing to pay the
additional costs of the time and inconvenience of clipping the
coupons and monitoring the sale periods.
32
Price Discrimination
Two-Part Pricing
Two-tariff
 Charging consumers a fixed fee for the right to purchase
a product and then a variable fee that is a function of the
number of units purchased.
 This is a pricing strategy used by buyers clubs, athletic
facilities, and travel resorts where customers pay a
membership or admission fee and then a per-unit charge
for the various products, services, or activities as members.
$
100
Green fee (variable cost);
= 1/2x 80x($100-$20)
=$3,200
2
60
1
Annual member/s fee
(Fixed cost)
3
20
MC
40 50
80
100
Rounds of golf
Quantity Discounts
Buy one, get the second one at half price.
Tying Arrangement
A buyer of one product is obligated to also buy a related product
from the same supplier