MANAGERIAL

ECONOMICS 11th 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
 Multiple-product Pricing
 Joint Products
 Joint Product Pricing Example
 Transfer Pricing
 Global Transfer Pricing Example
 Chapter 15
KEY CONCEPTS
 competitive market pricing
rule-of-thumb
 imperfectly competitive
pricing rule-of-thumb
 markup on cost
 profit margin
 optimal markup on cost
 markup on price
 optimal markup on price
 Lerner Index of Monopoly
Power
 price discrimination
 market segment
 first-degree price
discrimination
 second-degree price
discrimination
 third-degree price
discrimination
 by-product
 common costs
 vertical relation
 vertical integration
 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 on cost uses cost as a basis.
 Markup pricing is an efficient means for
achieving the profit maximization objective.
 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 discrimination exists if P1/P2 ≠ MC1/MC2.
 Ability to segment the market.
 Multiple markets with no reselling.
 Price elasticity of demand differs across submarkets.
 Degrees of Price Discrimination
 First degree: Different prices for each consumer.
 Creates maximum profits for sellers.
 Second degree: Block‑rates or quantity discounts.
 Third degree: Different prices by customer age, sex,
income, etc. (most common).
 Price Discrimination
Example
 Price/Output Determination
 Maximizes profits by setting MR=MC in each
market segment.
 One-price Alternative
 Without price discrimination, MR=MC for
customers as a group.
 With price discrimination, MR=MC for each
customer or customer segment.
 Profitable price discrimination benefits sellers
at the expense of some customers.
 Graphic Illustration
 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, treat as distinct products.
 For joint products produced in variable
proportions, set MRA=MCA and MRB=MCB.
 Common costs are joint product expenses.
 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.
 Transfer Pricing
 Transfer Pricing Problem
 Pricing transfer of products among divisions of a
single firm can become complicated.
 Products Without External Markets
 Marginal cost is the appropriate transfer price.
 Products With Competitive External Markets
 Market price is the optimal transfer price.
 Products With Imperfectly Competitive
External Markets
 Optimal transfer price is the marginal revenue
derived from combined internal and external
markets.
 Global Transfer Pricing Example
 Profit Maximization for an Integrated Firm
 Optimal transfer price is profit maximizing.
 Transfer Pricing with No External Market
 Optimal transfer price balances supply/demand.
 Competitive External Market with Excess
Internal Demand
 Firm employs own and external inputs.
 Competitive External Market with Excess
Internal Supply
 Firm supplies inputs to internal and external
markets.