Ch16- Pricing

It is important to note the following about the outcome of a firm using an optimal two-part tariff:

1. Because price equals marginal cost at the level of output supplied, the outcome is economically efficient. 2. All consumer surplus is transformed into profit. In practice, Disney can't convert all consumer surplus into profit because The demand curves of customers are not all the same. (2) Disney does not know precisely what these demand curves are.

Two-part tariff

A situation in which consumers pay one price (or tariff) for the right to buy as much of a related good as they want at a second price.

Perfect Price Discrimination

If a firm knew every consumer's willingness to pay—and could keep consumers who bought a product at a low price from reselling it—the firm could charge every consumer a different price. In this case of perfect price discrimination—also known as first-degree price discrimination—each consumer would have to pay a price equal to the consumer's willingness to pay and, therefore, would receive no consumer surplus. This extreme case helps us to see the two key results of price discrimination: 1. Profits increase. 2. Consumer surplus decreases.

Why Do Some Firms Use Cost-Plus Pricing?

Many firms use cost-plus pricing, which involves adding a percentage markup to average cost. Economists conclude that using cost-plus pricing may be the best way to determine the optimal price in two situations: 1. When marginal cost and average cost are roughly equal 2. When a firm has difficulty estimating its demand curve

Odd Pricing: Why Is the Price $2.99 Instead of $3.00?

Many firms use what is called odd pricing—for example, charging $4.95 instead of $5.00, or $199 instead of $200. If consumers have the illusion that $9.99 is significantly cheaper than $10.00, they will demand a greater quantity of goods at $9.99—and other odd prices—than the estimated demand curve predicts

Transactions costs

The costs in time and other resources that parties incur in the process of agreeing to and carrying out an exchange of goods or services. The law of one price holds exactly only if transactions costs are zero

price discrimination

by charging higher prices to some customers and lower prices to others

Yield management

is a sophisticated form of price discrimination in which firms rapidly adjust the prices of their goods and services based on the preferences of consumers and their responsiveness to changes in prices

Price discrimination

Charging different prices to different customers for the same product when the price differences are not due to differences in cost

The Requirements for Successful Price Discrimination

A successful strategy of price discrimination has three requirements: 1. A firm must possess market power. 2. Some consumers must have a greater willingness to pay for the product than other consumers, and the firm must be able to know what prices customers are willing to pay. 3. The firm must be able to divide up—or segment—the market for the product so that consumers who buy the product at a low price are not able to resell it at a high price. In other words, price discrimination will not work if arbitrage is possible. When firms can practice price discrimination, they will charge customers who are less sensitive to price—those whose demand for the product is less elastic—a higher price and charge customers who are more sensitive to price—those whose demand is more elastic—a lower price.

Arbitrage

According to the law of one price, identical products should sell for the same price everywhere. Buying a product in one market at a low price and reselling it in another market at a high price is referred to as arbitrage, and the profits received from engaging in arbitrage are referred to as arbitrage profits