Pricing in Practice

Is there a unique equilibrium price?

in

Pricing Strategy

most cases, no

Factors determining price

the the the

life cycle of a product aims of the firm degree of competition on costs and demand

information past

practices

Pricing and Market Structure

Limit pricing

The firms market power

the

AC new entrant
P
L

greater the power, the greater the discretion over price importance of strategy of rivals

the

AC monopolist

reactions

Limit pricing
where

potential entrants have higher AC

O Q

Q The limit price is likely to be higher,

A. the lower the average cost of a potential entrant. B. the higher the average cost of a potential entrant. C. the lower the average cost of the firm. D. the higher the average cost of the firm. E. the lower the price elasticity of demand for the firms product.
20% 20% 20% 20% 20%

Pricing and Market Structure

Alternative aims
alternative multiple

single aims

aims

A.

B.

C.

D.

E.

Alternative Pricing Strategies

A firms short-run average cost curve

Do firms know their costs and revenues?

difficulties

difficulties

in predicting rivals behaviour

Costs ()

in identifying the profitmaximising price and output

AVC a b

Cost-based pricing
the

use of a profit mark-up on AC

choosing the level of output

O

Output (Q)

A firms short-run average cost curve

Alternative Pricing Strategies

Do firms know their costs and revenues?

difficulties

Costs ()

in identifying the profitmaximising price and output in predicting rivals behaviour

c a b

AC AVC

difficulties

Cost-based pricing
the

use of a profit mark-up on AC

AFC
O

choosing the level of output choosing the mark-up

Output (Q)

Choosing the output and profit mark-up

The lower the output, the higher must be the profit mark-up per unit.

Q The higher the mark-up under a cost-based pricing system,

A. the higher the price, the higher the profit per unit and the lower the output. the lower the price, the higher the total profit and the higher the output. the lower the price, the higher the profit per unit and the higher the output. the higher the price, the total profit and the output. Although profit per unit will be higher, the effect on total profit, price and output will depend on circumstances.
20% 20% 20% 20% 20%

P1

AC
P2

B.

h g j
C.

D.

D
E.
O Q1 Q2

A.

B.

C.

D.

E.

Alternative Pricing Strategies

A firms supply curve based on average cost

Profit-per-unit mark-up

Do firms know their costs and revenues?

difficulties difficulties

S AC

in identifying the profitmaximising price and output in predicting rivals behaviour

Cost-based pricing
the

use of a profit mark-up on AC

choosing the level of output choosing the mark-up equilibrium price and output?
O

A firms supply curve based on average cost

Total profit mark-up

Alternative Pricing Strategies

Do firms know their costs and revenues?
difficulties

S AC

in identifying the profitmaximising price and output difficulties in predicting rivals behaviour

Cost-based pricing
the

use of a profit mark-up on AC

choosing the level of output choosing the mark-up equilibrium price and output?

variations

in the mark-up

How are prices determined?

Rise

Factors leading to a rise or fall in price

Number % 421 105 101 26 18 14 5 64 16 15 4 3 2 1 Fall Fall in material costs Rival price reduction Fall in demand Prices never fall Fall in interest rates Lower market share Rise in productivity Number 186 235 146 75 8 69 22 % 28 36 22 12 1 11 3

1st Market level Competitors prices Direct cost plus variable mark-up Direct cost plus fixed mark-up Customer set Regulatory agency 257 161 131 108 33 1

% 39 25 20 17 5 2

2nd 140 229 115 49 52 3

% 21 35 18 8 8 1

3rd 78 100 88 42 47 5

% 12 15 14 6 7 1

Rise in material costs Rival price increase Rise in demand Prices never rise Rise in interest rates Higher market share Fall in productivity

Q Price changes are more likely to be influenced by

A. cost factors in the case of a price rise and demand factors in the case of a price reduction. demand factors in the case of a price rise and cost factors in the case of a price reduction. cost factors in the case of both a price rise and a price reduction. demand factors in the case of both a price rise and a price reduction.

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Price Discrimination
Meaning of price discrimination Types of price discrimination
first

B.

degree

C.

D.

A.

B.

C.

D.

First-degree price discrimination

Profit-maximising single price = P1

First-degree price discrimination

Additional Gains = 2 + 3

2
P1 P1

1
P2

1 MC = AC
P2

3 MC = AC

AR = D

AR = D

MR
O
Q1

MR
Q O
Q1 Q2

Price Discrimination

Second-degree price discrimination

Profit-maximising single price = P* P*

Meaning of price discrimination Types of price discrimination

first

degree degree
AC MC MR
O
Q*

second

AR = D
Q

Second-degree price discrimination

Charging a range of prices depending on level of consumption (starting with P1)

Price Discrimination

Meaning of price discrimination Types of price discrimination

first

P1 P* P2

degree degree

second

P3

AC MC MR AR = D
Q3

third

degree

Q1

Q*

Q2

Third-degree price discrimination

P P

Third-degree price discrimination

P2 P1 P1

200

150

200

Q If a supermarket has a buy 2 get a 3rd

one free offer, this is an example of
A. first-degree price discrimination. B. second-degree price discrimination. C. third-degree price discrimination. D. demand pricing. E. mark-up pricing
A. B. C. D. E.
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Profit-maximising output under third degree price discrimination

DX O MRX O O

(a) Market X

Profit-maximising output under third degree price discrimination

Profit-maximising output under third degree price discrimination

DY DX O MRX O MRY O O MRX DX O

DY MRY O MRT

(a) Market X

(b) Market Y

(a) Market X

(b) Market Y

(c) Total (markets X + Y)

Profit-maximising output under third degree price discrimination

Profit-maximising output under third degree price discrimination

MC

MC

DY DX O MRX O MRY O MRT O MRX DX O

DY MRY O 3000 MRT

(a) Market X

(b) Market Y

(c) Total (markets X + Y)

(a) Market X

(b) Market Y

(c) Total (markets X + Y)

Profit-maximising output under third degree price discrimination

Profit-maximising output under third degree price discrimination

MC

MC

5 DY DX O MRX O MRY O 3000 MRT

5 DY DX O 1000 O MRX MRY O 3000 MRT

(a) Market X

(b) Market Y

(c) Total (markets X + Y)

(a) Market X

(b) Market Y

(c) Total (markets X + Y)

Profit-maximising output under third degree price discrimination

Profit-maximising output under third degree price discrimination

MC 9 5 DY DX O 1000 O MRX 2000 MRY O 3000 MRT O 1000 DX O MRX 2000 5 DY MRY O 3000

MC

MRT

(a) Market X

(b) Market Y

(c) Total (markets X + Y)

(a) Market X

(b) Market Y

(c) Total (markets X + Y)

Profit-maximising output under third degree price discrimination

Q Which one of the following conditions is NOT necessary for (third-degree) price discrimination to take place?
MC

A. The firm must be a monopoly. B. Price elasticity of demand must differ in each market.

20%

20%

20%

20%

20%

9 5

7 DY DX MRY O MRX 2000 O 3000 MRT

C. The firm must not be a price taker. D. The markets must be separate. E. People buying in the lowprice market must not be able to sell to those buying in the high-price market.

O 1000

(a) Market X

(b) Market Y

(c) Total (markets X + Y)

A.

B.

C.

D.

E.

Price Discrimination

Price Discrimination

Conditions for price discrimination

firm

The non-profit maximising firm

the

must be able to set its price must be separate elasticity must differ between

markets demand

firm can still make higher profits

markets

Price discrimination and the consumer

distribution competition profits

Advantages to the firm Other discriminatory pricing strategies

Peak-load

pricing pricing

Inter-temporal Two-part

tariff

Multiple Product Pricing

Transfer Pricing

Firms producing a range of products Interrelated demand

drawbacks full-range loss

Decentralised pricing in large organisations

problems of decentralised pricing

of independent pricing

Selling intermediate products by one part of a firm to another

use

pricing

of monopoly power within companies of transfer prices

leaders

meaning setting

Interrelated production
shared

of transfer prices

inputs

by-products

Use of marginal-cost pricing to overcome problems of internal monopoly power

Q If a profit-maximising oligopoly produces a semi-finished product in Country A and converts it into a finished product in Country B, and if a lower profit tax is charged in Country A, the firm will
A. Choose a high transfer price and a final price equal to marginal cost. B. Choose a high transfer price and a final price above marginal cost. C. Choose a low transfer price and a final price equal to marginal cost. D. Choose a low transfer price and a final price above marginal cost.
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Pricing and the Product Life Cycle

The nature of product life cycles

the

four stages

launch growth maturity decline

A.

B.

C.

D.

The stages in a products life cycle

The stages in a products life cycle

Product not becoming obsolete

Sales per period

Sales per period

Product becoming obsolete

Time

(1) Launch

(2) Growth

(3) Maturity

(4) Decline

Time

Pricing and the Product Life Cycle

The nature of product life cycles

the

Q In which stage is it likely that price competition is intense and firms invest in product innovation to stimulate growth in sales?
A. Launch B. Growth C. Maturity D. Decline
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four stages

launch growth maturity decline

Policy in each stage

the

launch stage the growth stage the maturity stage the decline stage

A.

B.

C.

D.