MANAGERIAL ECONOMICS

12th Edition

By
Mark Hirschey
Pricing Practices
Chapter 15
 Chapter 15
OVERVIEW
 Pricing Rules-of-thumb
 Markup Pricing And Profit Maximization
 Price Discrimination
 Price Discrimination Example
 Two-part Pricing
 Multiple-product Pricing
 Joint Products
 Joint Product Pricing Example
 Chapter 15
KEY CONCEPTS
 competitive market pricing  market segment
rule-of-thumb  first-degree price
 imperfectly competitive pricing discrimination
rule-of-thumb  second-degree price
 markup on cost discrimination
 profit margin  third-degree price
 optimal markup on cost discrimination
 markup on price  two-part pricing
 optimal markup on price  bundle pricing
 Lerner Index of Monopoly  by-product
Power  common costs
 peak periods  vertical relation
 off peak periods  vertical integration
 price discrimination  transfer pricing
 Pricing Rules-of-thumb
 Competitive Markets
 Profit maximization always requires setting Mπ
= MR - MC = 0, or MR=MC, to maximize profits.
 In competitive markets, P=MR, so profit maximization
requires setting P=MR= MC.
 Imperfectly Competitive Markets
 With imperfect competition, P > MR, so profit
maximization requires setting MR=MC.
 MR = P[1 + (1/εP)]
 Optimal P* = MC/[1 + (1/εP)]
 Markup Pricing and Profit
Maximization
 Optimal Markup on Cost
 Markup pricing is an efficient means for
achieving profit maximization.
 Markup on cost uses cost as a basis.
 Optimal markup on cost = -1/(εP + 1).
 Optimal Markup on Price
 Markup on price uses price as a basis.
 Optimal markup on price = -1/εP
 Price Discrimination
 Profit-Making Criteria
 Price elasticity of demand must differ in submarkets.
 Must have ability to prevent reselling.
 Price discrimination exists if P1/P2 ≠ MC1/MC2.
 Degrees of Price Discrimination
 First degree creates different prices for each
customer (maximum profits).
 Second degree gives quantity discounts.
 Third degree assigns different prices by customer
age, sex, income, etc. (most common).
 Price Discrimination Example
 Price/Output Determination
 To maximize profits, set MR=MC in each
market.
 One-price Alternative
 Without price discrimination, MR=MC for all
customers as a group.
 With price discrimination, MR=MC for each
customer or customer group.
 Profitable price discrimination benefits sellers
at the expense of some customers.
 Two-Part Pricing
 One-price Policy and Consumer Surplus
 A single price policy creates bargains for avid buyers;
they enjoy consumer surplus.
 Consumer surplus reflects unpaid benefit.
 Capturing Consumer Surplus With Two-part
Pricing
 Lump-sum prices plus user fees capture consumer
surplus for producers, e.g., club memberships.
 Consumer Surplus and Bundle Pricing
 When significant consumer surplus exists, profits can
be enhanced if products are purchased together.
 Multiple-product Pricing
 Demand Interrelations
 Cross-marginal revenue terms indicate how
product revenues are related to another.
 Production Interrelations
 Joint products may compete for resources or
be complementary.
 A by-product is any output customarily
produced as a direct result of an increase in
the production of some other output.
 Joint Products
 Joint Products in Variable Proportions
 If products are produced in variable proportions, they
are distinct outputs.
 For joint products produced in variable proportions,
set MRA= MCA and MRB= MCB.
 Allocation of common costs is wrong and arbitrary.
 Joint Products in Fixed Proportions
 Some products are produced in a fixed ratio.
 If Q = QA= QB, set MRQ= MRA+ MRB = MCQ.
 Joint Product Pricing Example
 Joint Products Without Excess By-product
 Profit-maximization requires setting MRQ= MRA+MRB
= MCQ.
 Marginal revenue from each byproduct makes a
contribution toward covering MCQ.
 Joint Production With Excess By-product
(Dumping)
 Profit-maximization requires setting MRQ=
MRA+MRB= MCQ.
 Primary product marginal revenue covers MCQ.
 Byproduct MR=MC=0.