CHP 14= Price discrimination and Pricing Strategy

DETAILED example 1 of bundling

many goods must be bought as a package -toyota doesn't sell engines, steering columns, and wheels, --IT SELLS IT AS A BUNDLE CALLED A CAR -it would be most difficult for most consumers to assemble the parts themselves

the PPD monopolist has an incentive to maximize his gains from trade which means

no deadweight loss

Total surplus increases with the practice of price discrimination only if: consumer surplus increases. output increases. producer surplus increases. price increases.

output increases.

Tying illustrates the benefits and the costs of price discrimination

-may increase output by lowering for low-volume price for low-volume users -spreads the fixed cost of R&D over more users encouraging innovation -extra money is pent to keep competitors out of the ink business

is price discrimination bad?

-price discrimination could be better or worse than single pricing -it is bad if the total output with price discrimination falls or stays the same -if output increases under discrimination, then total surplus will usually increase -Good: for those who wouldnt's originally purchase the good at a higher price, but now can since there is a PPD -BAD: bad for those who would have obtained some consumer surplus from purchase, but now can't

Continuation: is price discrimination bad?

-price discrimination helps cover fixed costs -***fixed costs remain the same while profits increase with market size -more profit encourages more research and development -creates incentives to increase output

DETAILED example of TYING

Hewlett Packard sells printers below cost and ink far above cost. The printer will only work with HP ink cartridges. Those with a high willingness to pay probably want to print a lot of photos. Tying causes high users to pay more per photo than low users.

Bundling is expected to provide greater profits when the two bundled goods are: I. substitutes. II. goods that have high fixed costs and low marginal costs. III. very close complements. II only I, II, and III I only II and III only

II. goods that have high fixed costs and low marginal costs. III. very close complements.

How does price discrimination help cover fixed costs? If price discrimination expands the size of the market, the fixed costs can be spread over a much larger output level. Consumers with elastic demand are less costly to serve, lowering the fixed costs of production. If price discrimination lowers profits, firms will produce less and have lower fixed costs. Consumers with inelastic demand are less costly to serve, lowering the fixed costs of production.

If price discrimination expands the size of the market, the fixed costs can be spread over a much larger output level.

DETAILED example 2 of bundling

Microsoft bundles Word, Excel, Outlook, Access, and PowerPoint in a bundle called Microsoft Office -but it would not be that difficult for consumers to buy the products individually and assemble them

Which of the following statements is TRUE? Even if demand curves are identical, it is still typically profit maximizing for monopolists to charge different prices in different markets. To maximize profits, monopolists will always set a higher price in markets with more inelastic demand curves. Monopolists typically prefer not to segment markets. Arbitrage makes it easier for firms to set different prices in different markets.

To maximize profits, monopolists will always set a higher price in markets with more inelastic demand curves.

Tying vs. Bundling The difference between tying and bundling, while generalized, can be boiled down as such:

Tying: "In order to purchase this good, you have to purchase this other good, which may or may not be related to the original good; not a package deal." Bundling: "If you buy this one good, you will also get this other good that is very likely related to the original good; package deal."

example of tying

automobile maker mandates that its vehicles only be serviced by its own dealers

The difference between tying and bundling is that: tying is more restrictive than bundling. bundled goods are sold one to one, while tied goods are sold one to many. bundling is more restrictive than tying. bundled goods are sold one to many, while tied goods are sold one to one.

bundled goods are sold one to one, while tied goods are sold one to many.

Requiring goods to be bought together in a single package is called: Tying. Bundling. Single package pricing.

bundling

Under perfect price discrimination: markets are segmented and each segment is charged a markup inversely proportional to the elasticity of demand. each customer is charged the average price that others with his or her characteristics are willing to pay. each customer is charged his or her maximum willingness to pay. it is easy to arbitrage.

each customer is charged his or her maximum willingness to pay.

to maximize profit, firms should set higher price in markets with more _____________demand

higher price in markets with more inelastic demand

To maximize profit the monopolist should set a: lower price in markets with more inelastic demand. higher price in markets with more inelastic demand. lower price in markets with less elastic demand. higher price in markets with more elastic demand.

higher price in markets with more inelastic demand.

In general, price discrimination exists because: higher prices are charged because some customers are willing to pay more. lower prices are possible when profits are not a goal of the entrepreneur. lower prices encourage arbitrage. higher prices are required when costs are higher.

higher prices are charged because some customers are wiling to pay more

Airlines try to differentiate their customers by willingness to pay based on: a person's weight. the ethnicity of a person's last name. All of the answers are correct. how long in advance a person books their flight.

how long in advance a person books their flight.

the principles of price discrimination

if demand curves differ, it's more profitable to set different prices in different markets than single price that covers all markets to maximize profit, firms should set higher price in markets with more inelastic demand arbitrage makes it difficult for a firm to set different priceesin different markets

A firm with market power can use price discrimination to: Decrease costs. Decrease output. Increase profits.

increase profits . A firm with market power can use price discrimination to increase profits.

Which of the following conditions would prevent a firm from setting different prices in different markets? law enforcement preventing smuggling from occurring government imposition of a price ceiling possibility of arbitrage for buyers between different markets government intervention forcing the firm to reduce the level of output

possibility of arbitrage for buyers between different markets ; arbitrage Arbitrage occurs when a security is purchased in one market and simultaneously sold in another market at a higher price, thus considered to be risk-free profit for the trader.

takeaways of this chapter:

price discrimination is common firms often price goods based on characteristics correlated with willingness to pay -student and senior discounts -setting prices depending on how far in advance a flight is booked -*** YOU HAVE TO PREVENT ARBITRAGE TO SUCCESSFULLY PRICE DISCRIMINATE -the more a firm knows about its customers, the better it can price discriminate -perfect price discrimination means charging each customer their max willingness to pay -tying and bundling are different forms of price discrimination -by increasing profits, price discrimination -by increasing profits, price discrimination increases the incentive to engage in R&D

bundling

requiring that products be bought together in a bundle or package EX.textbooks and access to necessary software; can purchase software elsewhere, but likely cheaper/ more convenient through bundle

Which of the following is an example of tying? set menus at a restaurant buy-one-get-one-free offers "value meals" at fast-food restaurants restrictions that prohibit patrons from bringing their own wine to restaurants

restrictions that prohibit patrons from bringing their own wine to restaurants

price discrimination

selling the same product at different prices to different customers

Price discrimination can be defined as: selling the same product in two different markets. exporting goods to foreign countries. selling different products to the same consumers in the same market. selling the same product at two different prices in two different markets.

selling the same product at two different prices in two different markets.

which of the following is an example of price-discrimination

senior citizen discounts

if demand curves differ, it's more profitable to:

set different prices in different markets than single price that covers all markets

arbitrage (IOW's)

simultaneous purchase & sale of commodity to profit from differing prices in different regions and/ or markets

arbitrage

taking advantage of (temporary) price differences for the same good in different markets by BUYING LOW in one market and SELLING high in another market

example of bundling

textbooks and access to necessary software; can purchase software elsewhere, but likely cheaper/ more convenient through bundle

Tying is: the same thing as buy one get one free. the practice of a firm's paying the sales tax in exchange for a consumer's purchase of an extended warranty. the practice of buying one unit at full price and the second unit at half off. the practice of a firm selling one product that requires the consumer to purchase another of the firm's products.

the practice of a firm selling one product that requires the consumer to purchase another of the firm's products.

the P monopoly > P perfect competitive

the price of monopoly is greater than the price of perfect competitve

Perfect price discrimination means charging each customer: The same amount. Their maximum willingness to pay. Their maximum ability to pay.

their maximum willingness to pay; so consumers enf up wih zero consumer surplus

Consumers have very different values for the separates but similar values for the package.

this enables price discrimination

tying

to use one good, a consumer must use a second good that is sold only by one firm; necessary to buy one good you may not want in orDer to get another good you may want -often illegal when products aren't naturally related EX.: automobile maker mandates that its vehicles only be services by its own dealers

price discrimination is better than single pricing if::

total surplus increases ; Price discrimination is better if it increases total surplus

increase in output under price discrimination

total surplus will increase as well

T/F if output increases under discrimination, then total surplus will usually increase

true

Hewlett Packard's pricing scheme is to sell printers at a relatively low price and ink cartridges at a relatively high price. This practice is known as: predation. retail maintenance. tying. leverage.

tying