Lecture 9 notes - Pricing and Advertising: Chapter Review...

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BE 530 Page 1 of 5 Lecture 9 Pricing and Advertising: Chapter Review Price Discrimination Price discrimination is the business practice of selling the same good at different prices to different customers. Price discrimination can only be practiced by a firm with market power such as a monopolist. There are three lessons to note about price discrimination: Price discrimination is a rational strategy for a profit-maximizing monopolist because a monopolist’s profits are increased when it charges each customer a price closer to his or her individual willingness to pay. Price discrimination is only possible if the monopolist is able to separate customers according to their willingness to pay—by age, income, location, etc. If there is arbitrage —the process of buying a good in one market at a low price and selling it in another market at a higher price—price discrimination is not possible. Price discrimination can raise economic welfare because output increases beyond that which would result under monopoly pricing. However, the additional surplus (reduced deadweight loss) is received by the producer, not the consumer. Perfect price discrimination occurs when a monopolist charges each customer his or her exact willingness to pay. In this case, the efficient quantity is produced and consumed and there is no deadweight loss. However, total surplus goes to the monopolist in the form of profit. In reality, perfect price discrimination cannot be accomplished. Imperfect price discrimination may raise, lower, or leave unchanged total surplus in a market. Examples of price discrimination include movie tickets, airline tickets, discount coupons, financial aid for college tuition, and quantity discounts. Prescription drug manufacturers charge different prices for the same drug when selling to people versus pets, and when selling to people from different countries. Sometimes price discrimination allows a manufacturer to sell drugs to the residents of poor countries at a discounted price so that more people receive the drug than would under a single-price policy. Sometimes differential pricing just raises prices. Advertising Since monopolistically competitive firms sell differentiated products at prices above marginal cost, each firm has incentive to advertise to attract more buyers. Firms that sell highly differentiated consumer products spend 10 to 20 percent of revenue on advertising, firms that sell industrial products spend little, and firms that sell undifferentiated products spend nothing at all. About 2 percent of firm revenue, or about $200 billion per year, is spent on advertising. In 2001, 31 percent of advertising spending was on commercials on television and radio, 24 percent on space in newspapers and
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BE 530 Page 2 of 5 Lecture 9 magazines, 19 percent on direct mail, 6 percent on the yellow pages, 3 percent on the
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This note was uploaded on 07/15/2011 for the course ACC 360 taught by Professor Marshallhunt during the Spring '09 term at University of Michigan-Dearborn.

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Lecture 9 notes - Pricing and Advertising: Chapter Review...

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