Chapter 11 (13 in book)
2 steps for how firms should decide what price to charge each group of consumers (3rd degree price discrimination)
1. we know that however much is produced total output should be divided between the groups of customers so that MR's for each group are equal (otherwise wont be maximizing profit) 2. we know that total output must be such that the MR for each group of consumers is = to MC of production. (because the costs of serving the different groups are not independent) ex. with unrestricted versus discounted air fares, increasing the number of seats sold at discounted fares affects the cost of selling unrestricted tickets - MC rises rapidly as the airplane fills up
block pricing
if scale economies cause AC and MC to decline, the government agency that controls rates may encourage xxxxx
capture all the consumer surplus through the use of bundling
negatively correlated consumers demands for two different goods allows a firm to...
block pricing definition
practice of charging different prices for different quantities or "blocks" of a good
consumer surplus
two part tariff provides another means of extracting
managers of a firm with market power have a harder job than those who manage perfectly competitive firms
a firm that is perfectly competitive in output markets has no influence over market price, a manager of PCM only needs to worry about cost side of firms operations - choosing a price that is = MC. manager of a firm with monopoly power needs to worry about characteristics of demand.
tradeoff for two part tariff for many firms
a lower entry fee means more entrants and thus more profit from sales of the item. on the other hand, as the entry fee becomes smaller and the number of entrants larger, the profit derived from the entry fee will fall. the problem then is to pick an entry fee that results in the optimum number of entrants - that is, the fee that allows for max profit.
bundling
a pricing strategy that involves tying products together and selling them as a package ex. a one week vacation (airfare, hotel, car,etc)
small elasticity of demand
a xxxxx implies a large markup of price over MC. Therefore the marginal profit from each extra unit solid is high. in this case, if advertising can help sell a few more units, it will be worth its cost.
example of second degree price discrimination
block pricing (often used by electric power companies, natural gas utilities, and municipal water companies)
negatively correlated
bundling is more profitable than selling the firms individually because the relative valuations of the two films are reversed, or demands are.... (customer is willing to pay the most for one movie is willing to pay to the least for another)
heterogenous demands and the firm cannot price discriminate
bundling makes sense when firms have xxxxx
first thing that one must do for 1st degree price discrimination
calculate the profit that the firm earns when charging a single price P* (up to Q*). MR-MC for every unit up to Q* (variable profit)
basic objective of every pricing strategy
capturing consumer surplus and converting it to additional profit for the firm
price discrimination
charging different prices to different customers, sometimes for the same product and sometimes for small variations in the product
meter demand
companies use tying to xxx and thereby practice price discrimination more effectively. ex. in 1950s when Xerox had a monopoly on copy machines but not on paper, customers who leased a xerox copy machine also had to buy xerox paper. this allowed xerox to xxxx (those who used the machine more, bought more paper) and then xerox applied a two part tariff accordingly
mixed bundling is ideal strategy when
demands are only somewhat negatively correlated and/or when MC are significant
objective of inter-temporal price discrimination
divide consumers into high-demand and low-demand groups by charging a price that is high at first but falls later (first, selling the product (high quality camera) at a high price bc the camera buffs will buy it and then selling it at a lower price for regular people to buy)
pure bundling
example of tying
very sensitive, is not very
firms should advertise a lot if demand xxxx to advertising (Ea is large) or if demand xxx price elastic (Ep is small)
problem for two part tariff
how to set entry fee (T) versus usage fee (P)
the two goods were sold separately
if a consumers demands for the two goods are perfectly correlated, then the firm would do equally as well if
it may not always be worthwhile for the firm to try to sell to more than one group of consumers
if demand is small for the second group and MC is rising steeply, the increased cost of producing and selling to this group may outweigh the increase in revenue
block pricing
if scale economies cause AC and MC to decline, the government agency that controls rates may encourage xxxxx because it leads to expanded output and greater scale economies. this policy can increase consumer welfare while allowing for greater profit to the company: While prices are reduced overall, the savings from lower unit cost still permits the company to increase its profit
MR, demand curve
if the firm can perfectly price discriminate (each customer is charged exactly what he/she is willing to pay), the xxx is no longer relevant to the firms output decision. Instead, the incremental revenue earned from each additional unit sold is simply the price paid for that unit; is therefore given by the xxxxx.
demand
in peak-load pricing, if the firm were a regulated monopolist, the firm should set the prices where xxxx = MC rather than MR = MC. in that case, consumers realize the entire efficiency gain. ex. selling more tickets for ski lifts or amusement parks on a weekday does not significantly raise the cost of selling tickets on the weekend. similarly, selling more electricity during off peak periods will not significantly increase the cost of selling electricity during peak periods. as a result, price and sales in each period can be determined independently by setting MC = MR for each period.
profit max expenditure rule for advertising
increase advertising until the MR from an additional dollar of advertising, MRads, just equals the full marginal cost of that advertising. That full MC is the sum of the dollar spent directly on the advertising and the marginal production cost resulting from the increased sales that the advertising brings about. Thus the firm should advertise up until that point
reservation price
maximum price that a customer is willing to pay for a good
reservation price of one consumer
mixed bundling is the most profitable strategy, even though demands are perfectly negatively correlated because MC exceeds the xxx. 13.17
advertising elasticity of demand
percentage change in quality demanded resulting from a 1% increase in advertising expenditures [(A/Q)(deltaQ/deltaA)]
never possible
perfect first degree price discrimination is almost.... as it is impractical to charge every customer a difference price and a firm does not know the reservation price of every customer
second degree price discrimination
practice of charging different prices per unit for different quantities of the same good or service. ex. a single lightbulb might be priced at 5$ whereas a box of 4 of the same bulb might be priced at 14$, where the average price per bulb is 3.50$
first degree price discrimination
practice of charging each customer his or her reservation price
peak-load pricing
practice of charging higher prices during peak periods when capacity constraints cause MC to be high
third degree price discrimination
practice of dividing consumers into two or more groups with separate demand curves different prices to each groups ex. regular versus special airline fares, premium versus non-premium brands of liquor, canned or frozen vegetables, discounts to students and senior citizens
tying
practice of requiring a customer to purchase one good in order to purchase another ex. buying a copy machine and needing to buy the paper from the same company
inter-temporal price discrimination
practice of separating consumers with different demand functions into different groups by charging different prices at different points in time.
1st degree price discrimination, 2nd, 3rd...
price discrimination can take 3 broad terms
how to use market power effectively
problem faced by managers is...
objective of peak-load pricing
rather than capturing consumer surplus, the goal is to increase economic efficiency by charging consumers prices that are close to MC. ex. roads and tunnels during rush hours, electricity during late summer afternoons, ski resort and amusement parks on weekends. MC is high during these peak periods because of capacity constraints. Prices should thus be higher during peak periods
advertising to sales ratio
ratio of a firms advertising expenditures to its sales (A/PQ)
two-part tariff
requiring customers to pay in advance for the right to purchase units of a good at a later time (and at an additional cost). ex. amusement park (entrance fee and then games), razors (the razor itself and then buying additional blades), tennis and swimming clubs (being a member, hourly rate for usage)
pure bundling
selling products only as a package
mixed bundling
selling two or more goods both as a package and individually (a package price below the sum of the individual prices)
managers must decide how to
set prices, choose quantities of factor inputs, and determine output in both the SR and LR to max profit
charging a few different prices
sometimes however firms can discriminate imperfectly by xxx by estimating customers reservation prices. often used by doctors, lawyers, accountants.. ex. a doctor usually charges someone of low income/low insurance a lesser amount than someone of the upperclass
variable profit
sum of profits on each incremental unit produced by a firm ie. profit ignoring fixed costs, area between MC and demand curve
with perfectly price discrimination in place...
the additional profit from producing and selling an incremental unit is now the difference between demand and MC
PB=r1+r2
the dividing line for whether people will buy the bundle is... if reservation price is above price, the consumers will buy it. if not, they wont.
how to capture all the consumer surplus (two consumers)
the firm should set the usage fee above the MC and then set the entry fee equal to the remaining consumer surplus of the consumer with the smaller demand
increases, greater
the peak-load pricing xxx the firms profit above what it would be if it charged one price for all periods. it is also more efficient: the sum of the producer and consumer surpluses is xxx because prices are closer to MC.
most prevalent form of price discriminating
third degree price discrimination
inter-temporal price discrimination and peak-load pricing
two other forms of price discrimination, both of which involve charging different prices at different times
less effective means of capturing consumer surplus
(two part tariff with many firms) if consumers have different demands for your product, you would probably want to set P well above MC and charge a lower entry fee T. setting a single price may do almost as well.
how to capture all the consumer surplus (single consumer)
(two part tariff), assume the firm knows the consumers demand curve. set the usage fee P = MC, and the entry fee T = total consumer surplus for each consumer
ideal situation for firms bc most of consumer surplus could be captured
(two part tariff with many firms) if consumers demands for your product are fairly similar, you would want to charge a price P that is close to MC and make the entry fee T large.
rule of thumb for advertising
A/PQ = - (Ea/Ep) ... it says that to maximize profit, the firm's advertising to sales ratio should be equal to minus the ratio of the advertising and price elasticities of demand
to determine relative prices for each group (3rd degree price discrimination)
P1/P2 = (1+1/Ed2)/(1+1/Ed1)
equation for how much advertising a firm should do
MRads = P(deltaQ/deltaA)=1 + MC(deltaQ/deltaA) (full MC of advertising) .... notice MR=MC
formula for how much advertising a firm should do
PQ(P,A)-C(Q)-A
fixed cost, outward and to the right
advertising is a xxxx and it causes demand to shift xxxx
protect the customer goodwill connected with the brand name
another use of tying is to xxxxx. ex. McDonalds franchisee had to purchase all materials and supplies from McDonalds
mixed bundling
with MC = 0 and two consumers having higher reservation prices, the best method is xxxx. this is because the demands are not perfectly negatively correlated: the two consumers who have high demands for both goods (B and C) are willing to pay more for the bundle than consumers A and D. in this case, we can increase the price of the bundle and sell this to the two consumers and charge the remaining consumers the highest amount for a single good. 13.18
