Mass Market Pricing. How to price to markets with large numbers of consumers. Looking forward . Concept of mass market demand Relationship between revenue and demand Profit maximising price levels Concept of elasticity Innovative pricing. Playing games with consumers.
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How to price to markets with large numbers of consumers
(High Margin, Low Consumer Surplus)
Price (same for all)
(Low Margin, High Consumer Surplus)
Few sales with high margins
Price (same for all)
Lots of sales with low margins
It’s like making a take-it-or-leave-it offer!
The change in TR going from 4 to 5 units is $991 = 995 – 4
To sell 4 units, price = $996
To sell 5 units, price = $995
P = $996
P = $995
Lose $1 per unit on 4 units
TR = area of rectangle
= 996*4 = 3984
Here, WTP is low ($600) and the lost revenue on previous units required to get the sale is large ($399) – net effect $201
= (Revenue from another unit) - (cost of another unit)
= Marginal Revenue - Marginal Cost
Produce so long as MR MC!
Stop when Marginal Revenue is $200
MR – MC goes negative here
Profit maximising price
Point where MR = MC
= reducing the bargaining power of buyers
= capturing more value from buyers with high WTP
Very powerful: right way to approach any decision in which
Look at the last increment: is it worth it?
Marginal thinking, for the firm:
Should I produce one more unit?
P = 1000 – Q
P = 1000 – Q
Total Revenue(smooth version)Smooth TR curve
Once we assume price is a smooth function of quantity, TR is also a smooth function of quantity
1000Q – Q2
1 unitMarginal revenue of 500th unit
MR of 500th unit = change in TR, 499 to 500 units = $1
NOTE: 1 = slope of the line through these points on the TR curve (slope = “rise over run”)
But, with smooth TR, quantity increments can be much smaller than 1 unit …
… and, this is useful!
The slope of a curve at a point is its instantaneous rate of change at that point(e.g., the change in TR for a minuscule change in quantity)
Notice anything special about this line?
FACT: The maximum of a function occurs at the point where its slope = 0
FACT: The instantaneous rate of change in TR at a given quantity is the slope of the line tangent to the TR curve at that quantity
where a, b and c are constants (may be positive, zero, or negative)
TR = PQ = 1000Q - Q 2
Notice: same as the answerobtained using brute-force
Same principle as before
Profit = 1000Q – Q2
1000 - 2Q* = 200
Q* = 400
P* = 1000 – Q* = $600.
Total Cost = 200Q + Q2.
Total Cost in Factory M = 200QM
Total Cost in Factory G = 150QG + QG2
The marginal revenue and marginal cost equations (for each plant) are:
Set MC = MR in both plants, solve for optimal quantities (2 eqs, 2 unknowns):
When the marginal cost in factory G is 300 + 2QG
A convenient measure of sensitivity for use in pricing
= elasticity for a “minuscule” percentage change in price
(derivative of quantity with respect to price, times price divided by quantity)
e.g., if 10% increase in price of oil decreases quantity by 20%, e = – 2
e.g., if eUS= – 2 and eAU= – 10, AU demand is more elastic
Elasticities calculated at current market prices
To maximise profit, set MR = MC
If the demand curve is actually straight, the elasticity is differentat different points on the line.
There is only one point at which the line has unit elasticity
How to use price discrimination to increase value and profits
“Triangles of Opportunity”
From social point of view, value is lost
Customers with WTP > MC not served = reduced surplus
From firm’s point of view, more opportunity lost
Many pay less than their WTP= reduced appropriation
Both “triangles of opportunity” attractive to firm
Do both & create more surplus = beneficial to society
For instance, discounts on the charge per mile per hundredweight areoffered for full-car shipments and for long-distance shipments
= segment the market.
Cappuccino for the lavish $3.50
Cappuccino for the thrifty $1.00
Will anyone say they are ‘lavish’?
What if you offer different coffees? One based on fair price to growers. The other not.
Cappuccino for the concerned $3.50
Cappuccino for the unconcerned $1.00
The difference is much less than the additional premium paid to growers for fair trade coffee.
But, caused a stir …
Cappuccino for the concerned $2.80
Cappuccino for the unconcerned $2.50
So there are constraints on the ability to price discriminate.
Hot chocolate $2.20
Caffe Mocha $2.75
White Chocolate Mocha $3.20
20 oz Cappuccino $3.40
Hot chocolate – no frills $2.20
Cappuccino – no frills $2.55
Mix them together – I feel special $2.75
Use different powder – I feel
very special $3.20
Make it huge – I feel greedy $3.40
All of these have approximately the same cost to the cafe
Achieved by discriminating on individual observables : charge different prices to different people.
Group pricingAchieved by discriminating on group observables: charge different prices to different groups whose WTPs are correlated with identifiable characteristics
VersioningAchieved by discriminating on features: charge more for products with special features of interest to high WTP customers
Ex: claiming you’re a student
**High-WTP buyers must care more about this extra feature than low-WTP buyers **
= ability to return on weekday
For price discrimination, feature should be one that high-WTP buyers value much more
WTP for car: $40,000
WTP for car with GPS: $48,000
WTP for the feature = $8,000
WTP for car: $30,000
WTP for car with GPS: $31,000
Q: How much extra is the high-WTP buyer going to pay for the version “with feature”?
= her WTP for the feature
= extra utility she gets from having the feature
Example of GPS:
High-WTP buyer gets $8000 more utility from GPS
“feature” offered = no delay!
(From a marketing point of view, it’s better if they view this month’s product as “better,” e.g. hardback)
$60 – p > 0.5 ($60 - $40) = $10
The seller is using screening, that is, structuring prices to reveal information
might incur ill-will, maybe not worth it
Example: Student versions of software, printer models
= better version of the product (i.e., not crimped)
Moulding individual purchases
(In general, a demand function is composed of people with different willingness to pay for 1 unit, different willingness to pay for a second unit,… ex: Designer clothing store.)
Maximum possible surplus per customer
Notice that there are two different reasons to offer two-part pricing:
= the quantity a customer wants depends on the price
= customers buying more are more price-sensitive, more likely to walk away at a high price