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Pricing Strategies for the Firms

Pricing Strategies for the Firms. Week 10. Markup Pricing Profit Maximization and Markup Pricing Price Discrimination Definition Theoretical Models First Degree Second Degree Third Degree Price Discrimination Strategies Personalized Pricing Group Pricing Versioning Bundling

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Pricing Strategies for the Firms

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  1. Pricing Strategies for the Firms Week 10

  2. Markup Pricing • Profit Maximization and Markup Pricing • Price Discrimination • Definition • Theoretical Models • First Degree • Second Degree • Third Degree • Price Discrimination Strategies • Personalized Pricing • Group Pricing • Versioning • Bundling • Coupon and Sales • Two-Part Pricing • Macroeconomics and Pricing Policies

  3. Markup Pricing Cost-plus Pricing Calculating the price of a product by determining the average cost of producing the product and then setting the price a given percentage above that cost. P = average total cost + (m)(average total cost) = (1 + m) average variable cost where m is the markup on unit cost.

  4. Problems with cost-plus pricing • calculation of average variable cost • size of the markup Considers only cost of production and does not incorporate information on demand and consumer preferences. Thus, is not a profit-maximizing pricing strategy.

  5. Manager assumes that firms operates at 5,000 unit, i.e. cost per unit is $20. Since standard markup employed is 50%; then manager charges $30(=1.5x$20). Profit margin expected $10 (=$30-$20) per unit. If able to sell 5,000 units, then would earn $50,000 (=$10x5,000) 1 2 A $ Given actual D, only 4,000 units are sold at $30 per unit. 3 C 40 Actual profit is $48,000 (= ($30-$18)4,000 4 SMC C 30 D ATC 20 A $18 MR Q 3,000 4,000 5,000

  6. Observed Markup differs from one product to another Markup will probably change on a given product from time to time. Differs according to such factors as the degree of competitiveness in the market and the price elasticity of demand. Lower markup where competition is intense. Lower markup when price is more elastic.

  7. The Relationship between Marginal Revenue and the Price Elasticity of Demand

  8. The Profit-Maximizing Rule for Markup Pricing MR = MC

  9. Optimal markup: • where, • m = markup and • ep = price elasticity of demand

  10. No ep < 1 is included since MR is –ve then and profit max level of output never occurs where MR is –ve. • Optimal markup: The less elastic is the demand curve, the larger will be the markup. What types of goods have lesser elasticity? What types of markets?

  11. Price Discrimination Price discrimination is the practice of charging different prices to various groups of customers that are not based on differences in the costs of production.

  12. Why Do Companies Price Discriminate? $ 100 Some customers are willing to pay more than $60. Hence possible additional profit from consumer surplus; $800 (=1/2x40($100-$60)) 2 Price as a price controller; $60. Hence, profit; $1,600 (=$60-$20(40)) 60 1 Some customers are willing to pay if $20<P<$60. Hence possible additional profit from consumer surplus; $800 (=1/2x40($60-$20)) 3 20 MC Rounds of golf 40 80 100 50 By charging such customers a different price, the company could profitably sell to a much larger customer base.

  13. Conditions for price discrimination • Firms must possess some degree of monopoly or market power • that enables them to charge a price in excess of the costs of production • 2. Firm can prevent or limit arbitrage • the markets in which the products are sold must by separated (no resale between markets) • products with identical costs are sold in different markets at different prices • 3. Consumers differ in their demand for a given good or service • The demand curves in the market must have different elasticities • Firms must be able to separate customers into different groups that have varying price elasticities of demand

  14. Price Discrimination First Degree • seller can identify where each consumer lies on the demand curve and charges each consumer the highest price the consumer is willing to pay • price varies by customer's willingness or ability to pay • allows the seller to extract the greatest amount of profits • requires a considerable amount of information

  15. $ 100 Some customers are willing to pay more than $60. Hence possible additional profit from consumer surplus; $800 [=1/2x40($100-$60) 2 Price as a price controller or monopolist; $60. Hence, profit; $1,600 (=$60-$20(40) 60 1 Some customers are willing to pay if $20<P<$60. Hence possible additional profit from consumer surplus; $800 [=1/2x40($60-$20) 3 20 MC Rounds of golf 40 80 100 50 New TR with 1st Degree; $1,600+$800+$800=$3,200.

  16. An example: Medicine Regular Extra strength • 200 mg of active ingredient • 3 times daily • 18 pills in a box • $9.99 each box • 300 mg of active ingredient • 2 times daily • 12 pills in a box • $15.99 each box

  17. Personalized pricing strategy where companies set different prices for customers based on the personal information they have about the customers. Businesses recognize that buyers value any given product or service differently. Wealthier consumers often pay higher prices for services than less-affluent people do. The most common examples of such pricing practices occur in medical and legal services. Colleges and universities also practice income-based pricing by tailoring financial aid packages to each student's ability to pay.

  18. The online retailer, Amazon.com, only asks for your name when your register on the website, but it carefully tracks what you have purchased and collects personal information about your buying habits. Amazon.com uses this information in different ways. Once you make a purchase, you are presented with recommendations based on previous purchases. Personalisationhelps them identify your interests and your willingness to pay. When it was discovered that Amazon.com was selling the same digital video disc (DVD) at different prices to different customers, Amazon.com claimed it was only "price testing"

  19. Websites Websites like MP3.com, a digital music site, and NYTimes.com, the online face of The New York Times, use cookies that store information about the identity of users on their computers so that they can identify these users when they visit. These sites can track all the things users view online: the information they look up, the games they play and their purchases.

  20. Price Discrimination Second Degree • price varies according to quantity sold • Larger quantities are available at a lower unit price. • differential prices charged by blocks of services • requires metering of services consumed by buyers It is also called indirect price discrimination: a setting where a menu of options is offered to all and customers choose which option is best for them.

  21. Customers pay different prices depending on the quantity purchased. $ 1 A First degree revenue = 0ADQ1 2 Second degree; able to sell at 3 block of price; P3; 2. P2; and 3. P3. Thus revenue = 0P3BQ3+Q3ECQ2+Q2FDQ1 3 B P3 E C P2 F D MC P1 Q 0 Q3 Q2 Q1

  22. Price Discrimination Third Degree • price varies by attributes of customers • A pricing strategy under which firms with market power separate markets according to the price elasticity of demand and charge a higher price (relative to cost) in the market with the more inelastic demand • customers are segregated into different markets and charged different prices in each • segmentation can be based on any characteristic such as age, location, gender, income, etc Group Pricing

  23. Price Discrimination Third Degree Income Protease inhibitors and other AIDs drugs in Norway and Africa. Norway; higher income thus their demand is more inelastic. Africa: price should be lower becoz demand is more price-sensitive. Should be But Norway: lower price though demand is more in Africa. Why?

  24. Price Discrimination Third Degree Total Market $ Market A $ $ Market B MCT P DT DB DA MRT MRB MRA Q Q Q QT • assume the firm operates in two markets, A and B • the demand in market A is less elastic than the demand in market B • the entire market faced by the firm is described by the horizontal sum of the demand and marginal revenue curves …

  25. Price Discrimination Third Degree Total Market $ $ $ Market A Market B MCT P DT DB DA MRT MRB MRA Q Q Q QT • the firm finds the total amount to produce by equating the marginal revenue and marginal cost in the market as a whole: QT • if the firm were forced to charge a uniform price, it would find the price by examining the aggregate demand DT at the output level QT • the firm can increase its profits by charging a different price in each market …

  26. Price Discrimination Third Degree Market A Market B Total Market $ $ $ MCT P DT DB DA MRT MRB MRA Q Q Q QT QA QB • in order to find the optimum price to charge in each market, draw a horizontal line back from the MRT/MCT intersection • where this line intersects each submarket’s MR curve determines the amount that should be sold in each market: QA and QB • these quantities are then used to determine the price in each market using the demand curves DA and DB

  27. A monopolist sells in two geographically divided markets, A and B. Marginal cost is constant at $50 in both markets. Demand and marginal revenue in each market are as follows: QA = 900 – 2PA MRA = 450 - QA QB = 700 – PB MRB = 700 - 2QB Find the profit-maximizing price and quantity in each market. In which market is demand more elastic?

  28. Price Discrimination Versioning • Offering different versions of a product to different groups of customers at various prices, with the versions designed to meet the needs of the specific groups. • Book publishers have long used versioning when they publish a hardcover edition of a book and then wait a number of months before the cheaper paperback edition is released.

  29. Movie studios sometimes release special editions of movies. For instance, the DVD version of Shakespeare in Loveincludes additional features such as director and actor interviews, deleted scenes, a wide-screen edition, and closed captioning for US$32.99, whereas the VHS version has no bonus materials and costs $14.99. Intuit, a software company, offers TurboTax for US$29.95 and TurboTax Deluxe, which includes additional features including "more money saving advice" and Internal Revenue Service publications for $39.95.

  30. Price Discrimination Bundling • Bundling involves selling multiple products as a bundle where the price of the bundle is less than the sum of the prices of the individual products or where the bundle reduces the dispersion in willingness to pay. • Microsoft Office bundles its products together, but also sells them separately. The next time you walk into your favourite electronics store and inquire about the price of a personal computer, you will notice that you can buy a computer (CPU), a monitor and a printer in one package. In addition, these packages also commonly include certain software programs and perhaps a DVD player, a compact disc (CD) writer and free access to the Internet for a limited time.

  31. Price Discrimination Coupons and Sales • Using coupons and sales to lower the price of the product for those customers willing to incur the costs of using these devices as opposed to lowering the price of the product for all customers. • Those individuals who clip coupons or watch newspaper advertisements for sales are more price sensitive than consumers who do not engage in these activities, and they are also willing to pay the additional costs of the time and inconvenience of clipping the coupons and monitoring the sale periods.

  32. Price Discrimination Two-Part Pricing Two-tariff • Charging consumers a fixed fee for the right to purchase a product and then a variable fee that is a function of the number of units purchased. • This is a pricing strategy used by buyers clubs, athletic facilities, and travel resorts where customers pay a membership or admission fee and then a per-unit charge for the various products, services, or activities as members.

  33. $ 100 Green fee (variable cost); = 1/2x 80x($100-$20) =$3,200 2 60 1 Annual member/s fee (Fixed cost) 3 20 MC Rounds of golf 40 80 100 50

  34. Quantity Discounts Buy one, get the second one at half price. Tying Arrangement A buyer of one product is obligated to also buy a related product from the same supplier

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