MANAGERIAL
th
ECONOMICS 11 Edition
By
Mark Hirschey
Pricing Practices
Chapter 15
Chapter 15
OVERVIEW
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Pricing Rules-of-thumb
Markup Pricing And Profit Maximization
Price Discrimination
Price Discrimination Example
Multiple-product Pricing
Joint Products
Joint Product Pricing Example
Transfer Pricing
Global Transfer Pricing Example
Chapter 15
KEY CONCEPTS
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competitive market
pricing rule-of-thumb
imperfectly competitive
pricing rule-of-thumb
markup on cost
profit margin
optimal markup on cost
markup on price
optimal markup on price
Lerner Index of Monopoly
Power
price discrimination
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market segment
first-degree price
discrimination
second-degree price
discrimination
third-degree price
discrimination
by-product
common costs
vertical relation
vertical integration
transfer pricing
Pricing Rules-of-thumb
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Competitive Markets
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Profit maximization always requires setting Mπ
= MR - MC = 0, or MR=MC, to maximize profits.
In competitive markets, P=MR, so profit maximization
requires setting P=MR= MC.
Imperfectly Competitive Markets
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With imperfect competition, P > MR, so profit
maximization requires setting MR=MC.
MR = P[1 + (1/εP)]
Optimal P* = MC/[1 + (1/εP)]
Markup Pricing And Profit
Maximization
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Optimal Markup on Cost
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Markup on cost uses cost as a basis.
Markup pricing is an efficient means for
achieving the profit maximization objective.
Optimal markup on cost = -1/(εP + 1)
Optimal Markup on Price
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Markup on price uses price as a basis.
Optimal markup on price = -1/εP
Price Discrimination
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Profit-Making Criteria
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Price discrimination exists if P1/P2 ≠ MC1/MC2.
Ability to segment the market.
Multiple markets with no reselling.
Price elasticity of demand differs across submarkets.
Degrees of Price Discrimination
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First degree: Different prices for each consumer.
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Creates maximum profits for sellers.
Second degree: Block-rates or quantity discounts.
Third degree: Different prices by customer age, sex,
income, etc. (most common).
Price Discrimination Example
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Price/Output Determination
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One-price Alternative
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Maximizes profits by setting MR=MC in each market
segment.
Without price discrimination, MR=MC for customers
as a group.
With price discrimination, MR=MC for each customer
or customer segment.
Profitable price discrimination benefits sellers at the
expense of some customers.
Graphic Illustration
Multiple-product Pricing
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Demand Interrelations
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Cross-marginal revenue terms indicate how
product revenues are related to another.
Production Interrelations
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Joint products may compete for resources or
be complementary.
A by-product is any output customarily
produced as a direct result of an increase in
the production of some other output.
Joint Products
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Joint Products in Variable Proportions
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If products are produced in variable
proportions, treat as distinct products.
For joint products produced in variable
proportions, set MRA=MCA and MRB=MCB.
Common costs are joint product expenses.
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Allocation of common costs is wrong and arbitrary.
Joint Products in Fixed Proportions
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Some products are produced in a fixed ratio.
If Q=QA=QB, set MRQ=MRA+MRB=MCQ.
Joint Product Pricing Example
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Joint Products Without Excess By-product
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Profit-maximization requires setting
MRQ=MRA+MRB=MCQ.
Marginal revenue from each byproduct makes
a contribution toward covering MCQ.
Joint Production With Excess By-product
(Dumping)
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Profit-maximization requires setting
MRQ=MRA+MRB=MCQ.
Primary product marginal revenue covers MCQ.
 Byproduct MR=MC=0.
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Transfer Pricing
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Transfer Pricing Problem
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Products Without External Markets
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Marginal cost is the appropriate transfer price.
Products With Competitive External Markets
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Pricing transfer of products among divisions of a
single firm can become complicated.
Market price is the optimal transfer price.
Products With Imperfectly Competitive External
Markets
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Optimal transfer price is the marginal revenue derived
from combined internal and external markets.
Global Transfer Pricing Example
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Profit Maximization for an Integrated Firm
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Transfer Pricing with No External Market
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Optimal transfer price balances supply/demand.
Competitive External Market with Excess Internal
Demand
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Optimal transfer price is profit maximizing.
Firm employs own and external inputs.
Competitive External Market with Excess Internal
Supply
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Firm supplies inputs to internal and external markets.