Microeconomics Chapter 16

Do airlines practice price discrimination​?

Airlines engage in price discrimination by reducing the price on seats that they expect will not be sold.

For government​ officials:

Marginal revenue equals marginal cost at 150 ​tickets, and the airline can sell that many tickets to government officials at a price of​ $175 per ticket.

Consumer surplus

the area under the demand curve and above the price.

The most obvious problems with​ cost-plus pricing​ are:

1. It ignores demand and focuses on average cost rather than marginal cost. 2. If the​ firm's marginal cost is significantly different from its average cost at its current level of​ production, cost-plus pricing is unlikely to maximize profits.

A​ 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.

Odd​ pricing

An example of odd pricing would be charging​ $4.95 instead of​ $5.00 or​ $199 instead of​ $200. 1. Firms may have traditionally used odd pricing because when goods imported from Great​ Britain, which had a reputation for high​ quality, they were priced in U.S. currency instead of British​ pounds, the result was an odd price. Because customers may have connected odd prices with​ high-quality goods, even sellers of domestic goods began charging odd prices. 2.​ Alternatively, odd pricing may guard against employee theft because an odd price forces an employee to give the customer​ change, reducing the likelihood that the employee would simply pocket the​ customer's money without recording the sale. 3. Firms still use odd pricing today because an odd price that is a penny or a nickel less than a round number seems somehow significantly less.

What potentially limits price​ discrimination?

A​ firm's ability to practice price discrimination will be limited if consumers who can buy a good at a low price resell it to consumers who would otherwise have to pay high prices.

When should firms use​ cost-plus pricing?

Cost-plus pricing may be the best way to determine the optimal price when marginal and average cost are roughly equal and the firm has difficulty estimating its demand curve.

Examples of Price Discrimination

Examples​: 1. DVD​ players, digital​ cameras, and​ flat-screen plasma televisions all sold for very high prices when they were first introduced. After the demand of the early adopters was​ satisfied, the companies reduced prices to attract more​ price-sensitive customers. 2. Book publishers charging much higher prices for hardcover​ editions, which are published months before paperback editions. ≻An airline charging higher prices for business travelers than for leisure travelers. ≻A golf course charging higher prices for weekend tee- times than for weekday tee−times. ​However, price discrimination does not include examples where the price differences are due to differences in cost.

Why have some firms traditionally used odd​ pricing?

Firms have traditionally used odd pricing because charging a nickel less than a round number somehow seems like a significant reduction. ​Similarly, charging ​$9.99 instead of ​$10.00 would be an example of odd pricing.

Profit​ maximization

For each segment of the​ market, the airline should maximize profits using price discrimination by selling the number of tickets for which marginal revenue equals marginal cost and then charge the price indicated by the demand curve for which that quantity of tickets can be sold.

Pricing​ strategies

In addition to price​ discrimination, firms use many different pricing​ strategies, depending on the nature of their​ products, the level of competition in their​ markets, and the characteristics of their customers. Examples: 1. Odd​ pricing, where a firm might charge​ $4.95 instead of​ $5.00 or​ $199 instead of​ $200. 2. ​Cost-plus pricing, where firms add a percentage markup to average cost. 3. ​Two-part tariffs, where consumers pay one price​ (or tariff) for the right to buy as much of a related good as they want at a second price.

Is price discrimination​ illegal?

In recent​ years, the courts have interpreted​ Robinson-Patman Act such that price discrimination is illegal if it reduces competition, , but which also contained language that could be interpreted as making illegal all price discrimination not based on differences in cost.

Cost-plus pricing

Involves adding a percentage markup to average cost. This pricing strategy​ doesn't appear to maximize profits unless the​ cost-plus price is the same as the price that will cause the quantity sold to be where marginal revenue is equal to marginal cost. ______________may be a good way to come close to the​ profit-maximizing price when either marginal revenue or marginal cost is difficult to calculate. ​Thus, __________________may be the best way to determine the optimal price when marginal and average cost are roughly equal and when the firm has difficulty estimating its demand curve.

For business​ travelers:

Marginal revenue equals marginal cost at 200 ​tickets, and the airline can sell that many tickets to business travelers at a price of​ $300 per ticket.

Key limit

The possibility in some circumstances that consumers who can buy a good at a low price will resell it to consumers who would otherwise have to buy at a high price.

Price discrimination

The practice of charging different prices to different customers for the same product when the price differences are not due to differences in cost. There are​ limits, though, to the ability of firms to charge different prices for the same product.

Airlines practice price discrimination​

because: 1. Airlines seats are a perishable product. 2. The marginal cost of flying one additional passenger is low. For​ example, airlines: 1. Charge business travelers and leisure travelers different prices. 2. Charge lower prices for tickets purchased well in advance of the flight. 3. Reduce the price on seats that they expect will not be sold. 4. Charge lower prices to passengers who will stay at their destination over a Saturday night.

A typical example of price discrimination over time would be when a company

charges higher prices for digital cameras when they are first introduced and lower prices later. With price discrimination over​ time, firms charge a higher price for a product when it is first introduced and a lower price later.

Perfect price discrimination

each consumer would have to pay a price equal to the​ consumer's willingness to pay. ​Therefore: 1. Consumers would receive no consumer surplus. 2. The​ monopolist's marginal revenue curve becomes its demand curve. 3. The firm will continue to produce up to the point where price is equal to marginal cost. 4. The ability to perfectly price discriminate causes the monopolist to produce the efficient level of output. By doing​ so, it creates no deadweight loss. 5. The monopoly converts all consumer surplus into profit. In​ sum, profit equals the area under the demand curve and above the marginal cost curve.

According to the law of one price

identical products should sell for the same price everywhere.

The law of one price

identical products should sell for the same price everywhere. It holds exactly only if transaction costs are zero. Apart from this important​ qualification, arbitrage will result in a product selling for the same price everywhere. ​However, firms differentiate the products they sell in many ways. One way is by providing faster and more reliable service than competitors. When such differences​ exist, _____________may appear to be violated even where transaction costs are zero and a product can be resold.

The law of one price may not hold even when transaction costs are zero because

the company of one product may have a better customer reputation than its competitors.

Arbitrage

the practice of buying a product in one market at a low price and reselling it in another market at a high price​, will result in a product selling for the same price everywhere.

Marginal cost

the price per unit of output

Arbitrage would be prevented from ensuring that identical products sell for the same price everywhere if

transaction costs are high.

What is required for the law of one price to​ hold? The law of one price will hold exactly if

transaction costs associated with arbitrage are zero.

Does​ cost-plus pricing have any​ shortcomings?

​Cost-plus pricing is limited in that it ignores marginal cost.

Leisure​ travelers:

≻Are flexible about when they travel. ≻Are willing to buy their tickets well in advance. ≻Are sensitive to changes in price. ​Therefore, demand for business travelers is more​ inelastic, and airlines consequently charge them higher prices.

Business​ travelers:

≻Often have inflexible schedules. ≻​Can't commit until the last minute to traveling on a particular day. ≻Are not very sensitive to changes in price.