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Pricing Policy

- uniform pricing
- complete price discrimination
- direct segment discrimination
- indirect segment discrimination
- bundling

Northwest AirlinesMinneapolis-New York

Uniform Pricing

80

Price (Thousand Yen per unit)

55

marginal cost

30

demand

marginal revenue

0

2500

5000

Quantity (Units a year)

Uniform Pricing: Profit Maximum

- MR = MC
- Equivalently, set the incremental margin percentage equal to the inverse of absolute value of price elasticity of demand,
(price - MC) / price = -1/e

Price Elasticity

- always set price so that demand is elastic
- if demand more elastic, then lower incremental margin percentage (IM%) e = -2 IM% = 1/2
- e = -1.5 IM% = 2/3

Pricing Private-Label Cola

Suppose that WalMart learns that demand for private-label cola is less elastic than the demand for Coca Cola. Should WalMart set a higher price for private-label cola?

Uniform Pricing: Shortcomings

- leaves buyers with a lot of surplus
- does not sell to every potential buyer

Complete Price Discrimination

- price each unit at buyer’s benefit and sell quantity where MB = MC
- maximum profit -- theoretical ideal
- different from MR = MC

- implementation: must know entire marginal benefit and marginal cost curves

Complete Price Discrimination: Practice

- bargaining
- auctions

Direct Segment Discrimination, I

- price by segment
- implementation
- fixed identifiable characteristic --- basic for segmentation
- no re-sale

Direct Segment Discrimination, II

simple case: uniform price within each segment

- within each segment IM% = -1/e
- for segment with more elastic demand, then lower incremental margin percentage (IM%)

Direct Segment Discrimination, III

(a) Men’s demand

(b) Women’s demand

demand

80

Price (Thousand Yen per unit)

Price (Thousand Yen per unit)

55

50

marginal

revenue

marginal

cost

40

marg.

cost

30

30

demand

marginal revenue

0

2500

3000

0

1000

Quantity (Units a year)

Quantity (Units a year)

NYNEX Telephone Service

New York City

- residential -- $16/month
- business -- $23/month
How is discrimination possible?

Indirect Segment Discrimination

- structure choice to earn different incremental margins from each segment
- implementation
- seller controls some variable to which segments are differentially sensitive
- buyers cannot circumvent the variable

Air Travel: Indirect Segment Discrimination

*MC=200

Bundling

- strategy
- pure bundling
- mixed bundling

Pure or Mixed Bundling

What is the profit-maximizing pricing policy if

- marginal cost per channel = 0
- marginal cost per channel = $5

Pure or Mixed Bundling

- Generally,
- if item is costless, no loss from giving it to every consumer --> pure bundling;
- if item is costly, then should avoid providing it to low-benefit users --> use mixed bundling to screen out low-benefit users.
- Mixed bundling is form of indirect segment discrimination
- structured choice between bundle and separates

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