Lecture 12 - Additional Pricing Strategies and Concluding Topics.pptx

# Lecture 12 - Additional Pricing Strategies and Concluding Topics.pptx

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LECTURE 12 (4/26) Managerial Economics – Dr. Rishe PMBA – Wash U (Spring 2016) 1

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OUTLINE Additional Pricing Strategies Simple rule using elasticity and MC Extracting consumer surplus 3 rd degree Price Discrimination 2 nd degree price discrimination Two part pricing Block pricing Commodity bundling Cross-subsidies Price matching Randomized pricing Pricing when uncertainty is present Concluding Topics Natural Monopolies (Section 15.3) Understanding the basics of the labor market (sections 16.1, 16.3, and 16.7) Labor-leisure choice model (sections 17.1, 17.2) Compensating Wage Differentials (section 17.4) Public Goods and Externalities (sections 20.1, 20.3) 2

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A SIMPLE PRICING RULE FOR MONOPOLY AND MONOP COMPT FIRMS In a perfect world for ‘price setting’, we’d like to have: A DEMAND FUNCTION QDx = 500 – 4 Px + 0.5 Py + 0.25 M + 0.1 Advt A COST FUNCTION TC = 1000 + 4 Q + Q^2 But if we don’t have both, there is a simplified way to determine the profit-maximizing markup at any production level…as long as you have some idea of: Your Elasticity of Demand Your MC at that production level P = ( E / (1 + E) ) * MC Only applies for monopoly and MC firms because: PC firms are price takers Oligopoly is typically governed by ‘price rigidity’ 4
PRACTICE PROBLEM USING MARKUP RULE The manager of a convenience store buys Cola from a supplier at \$1.25 per bottle. The manager believes the elast of demand for the Cola in the neighborhood is -4 (highly elastic) What price should they charge? P = (4/3) * 1.25 = \$1.67 per bottle 5

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ANOTHER PRACTICE PROBLEM USING MARKUP RULE You own a Saturn dealership, the MC of a mid-sized Saturn is \$20,000, and the elasticity of demand for the Saturn is -2.5. What price should they charge? P = [ -2.5 / -1.5] * \$20,000 = \$33,333 6
VARIOUS WAYS OF EXTRACTING CONSUMER SURPL 3 rd degree pricing 2 nd degree pricing Two-part pricing Block pricing 7

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3 RD DEGREE PRICING RULE MR = P * [ ( 1 + E) / E] Since we set MR = MC, then profit-max occurs at P [ (1 + E) / E ] = MC. For example, suppose you run a restaurant, and: MC of meal prep is \$8 Demand elasticity of ‘lunch time’ consumers is -1.8, but… Demand elasticity of ‘dinner time’ consumers is -1.2. This difference in demand elasticity justifies charging lunch v dinner prices So for price determination: Lunch P (-0.8 / -1.8) = 8……or P = \$18 Dinner P (-0.2 / -1.2) = 8……or P = \$48. 8
TWO-PART PRICING E.g. Country clubs, fitness centers, Personal Seat Licenses You pay a one-time buy-in upfront fee, and then monthly, annual, or ‘per use’ dues The trick here, from a pricing perspective, is you: Try to set the upfront fee = consumer surplus, which requires setting P = MC and calculate CS.

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