Week 6B

Week 6B - Comm/FRE 295 Pricing Strategies With Market Power...

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1 Comm/FRE 295 October 14, 2010 Pricing Strategies With Market Power
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Learning Outcomes • Pricing Rule for TDPD (how optimal price ratio depends on demand elasticities) • Intertemporal Price Discrimination (TDPD over time) • Confusion between price discrimination and passing on cost savings • Two-Part Tariffs (how can fixed/admission fees raise profits?) • Bundling (how can selling goods bundled together raise profits?) 2
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Rule of Thumb for 3 rd Degree Price Discrimination • A firm with a single group of customers uses the following rule to maximize profits: (P - MC)/P = -1/E • A firm with 2 groups of customers chooses Q1 & Q2 (sales to group 1 and 2) to maximize profits: π = Rev1(Q1) + Rev2(Q2) –C(Q1 + Q2) • Use calculus to maximize: d π/dQ1 = d(Rev1)/dQ1 – dC/dQ1 = 0 MR1 = MC d π/dQ1 = d(Rev2)/dQ2 – dC/dQ2 = 0 MR2 = MC 3
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Rule for TDPD; Cont’n • Profits are maximized when MR1 = MR2 = MC • Recall from last lecture that MR = P(1 + 1/E) Combine to obtain P 1 (1 + 1/E 1 ) = P 2 (1 + 1/E 2 ) Notice that if group 1 has the most elastic demand, then E 1 < E 2 which implies P 1 < P 2 , as expected 4 1 2 2 1 1 1 + P E = P 1 1 + E   
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5 Intertemporal Price Discrimination (IPD) • TDPD over time (e.g., new electronics, movies, books); eager (patient) consumers have an inelastic (elastic) demand • TDPD charge a high price initially (exclude those with elastic demand) and eventually lower price (target the elastic demand consumers after serving inelastic demand consumers) • Usually no problem with consumer arbitrage • Solution procedure is same as TDPD, as discussed above
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Pricing of Ski Passes • Suppose the elasticity of demand for skiing is equal to -2 in March and -4 in April. The MC of serving skiers is the same for both months • How large of a price discount (expressed as a percent of the March price) should be offered to April skiers? 6
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7 Two-Part Tariff (TPT) • Common for firms to charge an up-front fee along with a price per unit consumed - Vancouver PNE charges $8 to enter and then $4 per ride - Internet provider charges $20 per month and $2 per 100 MB over base - Canadian Springs charges $130 per year for cooler and $7 per bottle - Gillette charges $12 for razor assembly and $10 per pack of ten blades - Golf courses charge $500 yearly membership fee and $40 per round • Optimal prices depend on the degree of heterogeneity of consumer demand
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Comparison to Volume Discounts • A TPT is similar to a volume discount • The higher the quantity consumed (Q), the lower the average fixed fee per unit of Q • Firms sometimes give consumers the choice between a straight cash price and a TPT; e.g., Whistler Edge Card • Allows firm to price discriminate by offering a lower price to high volume consumers
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9 Features of TPT • With no consumer heterogeneity, the outcome is the same as the first degree price discrimination (FDPD) outcome
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Week 6B - Comm/FRE 295 Pricing Strategies With Market Power...

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