Download Managerial Economics

Managerial Economics
ninth edition
Thomas
Maurice
Chapter 14
Advanced Pricing
Techniques
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Managerial Economics, 9e
Managerial Economics, 9e
Copyright © 2008 by the McGraw-Hill Companies, Inc. All rights reserved.
Managerial Economics
Advanced Pricing Techniques
• Price discrimination
• Multiple products
• Cost-plus pricing
14-2
Managerial Economics
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
Managerial Economics
The Trouble with Uniform Pricing
(Figure 14.1)
14-4
Managerial Economics
Price Discrimination
• Exists when the price-to-marginal
cost ratio differs between two
products:
PA
PB

MC A MCB
14-5
Managerial Economics
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
Managerial Economics
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
Managerial Economics
First-Degree (Perfect) Price
Discrimination (Figure 14.2)
14-8
Managerial Economics
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
Managerial Economics
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
Average price ( p) is:
TE A  fq
p

q
q
A
 f
q
14-10
Managerial Economics
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
Managerial Economics
Inverse Demand Curve for Each of 100
Identical Senior Golfers (Figure 14.3)
14-12
Managerial Economics
Demand at Northvale Golf Club
(Figure 14.4)
14-13
Managerial Economics
Second-Degree Price Discrimination
• Declining block pricing
• Offers quantity discounts over
successive discrete blocks of quantities
purchased
14-14
Managerial Economics
Block Pricing with Five Blocks
(Figure 14.5)
14-15
Managerial Economics
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
Managerial Economics
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
Managerial Economics
Allocating Sales Between Markets
(Figure 14.6)
14-18
Managerial Economics
Constructing the Marginal Revenue
Curve (Figure 14.7)
14-19
Managerial Economics
Profit-Maximization Under Third-Degree
Price Discrimination (Figure 14.8)
14-20
Managerial Economics
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
Managerial Economics
Multiple Products
• Related in production as substitutes
• For two products, X & Y, allocate
production facility so that
MRPX = MRPY
• Optimal level of facility usage in the
long run is where MRPT = MC
• For profit-maximization:
MRPT = MC = MRPX = MRPY
14-22
Managerial Economics
Multiple Products
• Related in production as complements
• To maximize profit, set joint marginal
revenue equal to marginal cost:
MRJ = MC
• If profit-maximizing level of joint
production exceeds output where MRJ
kinks, units beyond zero MR are
disposed of rather than sold
• Profit-maximizing prices are found using
demand functions for the two goods
14-23
Managerial Economics
Profit-Maximizing Allocation of
Production Facilities (Figure 14.9)
14-24
Managerial Economics
Profit-Maximization with Joint
Products (Figure 14.11)
14-25
Managerial Economics
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
14-26
Managerial Economics
Cost-Plus Pricing
• Does not generally produce profitmaximizing price
• Fails to incorporate information on
demand & marginal revenue
• Uses average, not marginal, cost
14-27
Managerial Economics
Practical Problems with Cost-Plus
Pricing (Figure 14.13)
14-28