Special Pricing Practices
EC611--Managerial Economics
Dr. Savvas C Savvides, European University Cyprus
Price Leadership
It may be hidden (covert) or implicit Collusion
Price leader may be:
Largest, dominant, or lowest-cost producing firm
in the industry
Leader’s demand curve is the total market
demand less the supply of the followers
The followers take the price set by the leader
as given and act as perfect competitors
They are price takers and face a horizontal
demand curve at the rice set by leader
Managerial Economics
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Price Leadership
Price
MCL
ΣMCF
3.00
2.50
2.00
DT
1.50
DL
1.25
MRL
1.00
50
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100
DR. SAVVAS C SAVVIDES
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Q
2
Price Discrimination
Charging different prices for a
product when the price differences are
not justified by cost differences.
Objective of the firm is to attain
higher profits than would be available
otherwise.
Î Price discrimination is different from
Price differentiation
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Price Discrimination
Conditions for Price Discrimination:
1.
2.
3.
Firm must be an imperfect
competitor (a price maker)
Price elasticity must differ for units
of the product sold at different
prices
Firm must be able to segment the
market and prevent resale of units
across market segments
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3rd-Degree Price Discrimination
Charging different prices for the same
product sold in different markets
Firm maximizes profits by selling a
quantity on each market such that the
marginal revenue on each market is
equal to the marginal cost of production
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Discriminating Oligopoly
Suppose an oligopolist supplies two separate
groups of customers
with differing elasticities of demand
Î e.g. business travellers may be less sensitive to
air fare levels than tourists
The oligopolist may increase profits by
charging higher prices to the businessmen
than to tourists.
Discrimination is more likely to be possible for
goods that cannot be resold
Î e.g. services consumed “on the spot”
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Examples of Price Discrimination
The charging of different rates / prices by:
telephone companies during “peak” vs. “off-peak”
periods (such as at night or on week-ends)
electricity companies to commercial users
compared with residential users
doctors to poor than to rich people
movie theatres for evening than for matinees
(morning) shows
bus and train companies for the elderly, students,
soldiers, etc
hotels for tourists than for locals or for conventions
and groups than for individuals
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3rd-Degree Price Discrimination
Q1 = 120 - 10 P1
Q2 = 120 - 20 P2
or Î P1 = 12 - 0.1 Q1
or Î P2 = 6 - 0.05 Q2
TR1 = 12 Q1 - 0.1 Q21
TR2 = 12Q - 0.1 Q22
ÎMR1 = 12 - 0.2 Q1
ÎMR2 = 6 - 0.1 Q2
MR1 = MC = 2
MR2 = MC = 2
MR1 = 12 - 0.2 Q1 = 2
MR2 = 6 - 0.1 Q2 = 2
Q1 = 50
Q2 = 40
P1 = 12 - 0.1 (50) = $7
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P2 = 6 - 0.05 (40) = $4
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3rd-Degree Price Discrimination
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International
Price Discrimination
Persistent Dumping
Predatory Dumping
Temporary sale at or below cost
Designed to bankrupt competitors
Trade restrictions apply
Sporadic Dumping
Occasional sale of surplus output
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Transfer Pricing
Pricing of intermediate products sold by
one division of a firm and purchased by
another division of the same firm
Made necessary by decentralization and
the creation of semiautonomous profit
centers within firms
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Transfer Pricing
No External Market
Transfer Price = Pt
MC of Intermediate Good = MCp
Pt = MCp
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Transfer Pricing
Competitive External Market
Transfer Price = Pt
MC of Intermediate Good = MC’p
Pt = MC’p
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Transfer Pricing
Imperfectly Competitive External Market
Transfer Price = Pt = $4
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External Market Price = Pe = $6
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Pricing in Practice
Cost-Plus Pricing
Markup or Full-Cost Pricing
Fully Allocated Average Cost (C)
Average variable cost at normal output
Allocated overhead
Markup on Cost (m) = (P - C)/C
Price = P = C (1 + m)
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Pricing in Practice
Optimal Markup
⎛
1 ⎞
MR = P ⎜1 +
⎟
E
⎝
P ⎠
⎛ EP ⎞
P = MR ⎜
⎜ E + 1 ⎟⎟
⎝ p
⎠
MR = C
⎛ EP ⎞
P =C⎜
⎜ E + 1 ⎟⎟
⎝ p
⎠
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Pricing in Practice
Optimal Markup
⎛ EP ⎞
P =C⎜
⎜ E + 1 ⎟⎟
⎝ p
⎠
P = C (1 + m)
⎛ EP ⎞
C (1 + m) = C ⎜
⎜ E + 1 ⎟⎟
⎝ p
⎠
EP
−1
m=
EP + 1
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Pricing in Practice
Two-Part Tariff: Consumers pay an initial fee
for the right to purchase/use a product/service,
plus a usage fee for each unit of consumption
Tying: Buying a product also requires the
purchase of another necessary for using the
first
Bundling: A form of tying requiring customers
buying one product to also buy a second one
Skimming: the setting of a high price when a
product is introduced and gradually lowering it.
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Uses of Break-Even Analysis
BE analysis can help in the following business
situations / decisions:
New Product development:
BE can determine the level of Q for the firm to achieve
profitability
Expansion of Operations:
Increasing sales would also increase the level of FC
and VC
Modernization and Automation Projects:
Fixed investments increase in order to lower VC
(especially labor) BE analysis can help
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