Title: Pricing
1Pricing
- ECG 507
- Professor Allen
- Fall 2005
21. Introduction
- Pricing without market power (perfect
competition) is determined by market supply and
demand. - The individual producer must be able to forecast
the market and then concentrate on managing
production (cost) to maximize profits.
32. Introduction
- Pricing with market power (imperfect competition)
requires the individual producer to know much
more about the characteristics of demand as well
as manage production.
43. Capturing Consumer Surplus
/Q
Pmax
A
If price is raised above P, the firm will lose
sales and reduce profit.
P1
P
B
P2
MC
PC
D
MR
Quantity
Q
54. Capturing Consumer Surplus
/Q
Pmax
A
If price is lowered the firm gains sales, but
loses revenue on previous sales and lowers
profits.
P1
P
B
P2
MC
PC
D
MR
Quantity
Q
65. Capturing Consumer Surplus
/Q
Pmax
A
How can the firm capture the consumer surplus in
A and B?
P1
P
B
P2
MC
PC
D
MR
Quantity
Q
76. Capturing Consumer Surplus
- Price discrimination is the charging of different
prices to different consumers. - Major types
- Same good, different prices (cars, cosmetics)
- Price diff gt cost diff (club floors in hotels)
- Price varies with consumption (pizza)
- Price varies by location (cement)
87. Firms price discriminate when
- Monopoly power in each market
- Able to identify each group
- No chance for arbitrage
98. Principles of price discrimination
- MR has to be the same in each market
- If not, you could increase TR by shifting output
from one market to another - MR in each market MC
- If not, you could increase profits by cutting
back output if MC gt MR (or increasing output if
MR gt MC)
109. Price Discrimination
- Using Elasticity to Set Price in Third Degree
Discrimination
1110. Price Discrimination
- Using Elasticity to Set Price in Third Degree
Discrimination
1211. Third-Degree Price Discrimination
/Q
Consumers are divided into two groups, with
separate demand curves for each group.
D2 AR2
MR2
D1 AR1
MR1
Quantity
1312. Third-Degree Price Discrimination
/Q
MRT MR1 MR2
D2 AR2
MRT
MR2
MR1
D1 AR1
Quantity
1413. Third-Degree Price Discrimination
/Q
P1
MC MR1 at Q1 and P1
MC
D2 AR2
MRT
MR2
D1 AR1
MR1
QT
Q1
Quantity
1514. Third-Degree Price Discrimination
/Q
MC MR2 at Q2 and P2 The more inelastic
the demand, the higher the price.
P1
MC
P2
D2 AR2
MRT
MR2
D1 AR1
MR1
QT
Q1
Q2
Quantity
1615. Second-Degree Price Discrimination
/Q
Second-degree price discrimination is
pricing according to quantity consumed--or in
blocks.
P1
P0
P2
P3
Q0
Q1
Q2
Q3
Quantity
1st Block
2nd Block
3rd Block
1716. Price Discrimination
- First Degree Price Discrimination
- Charge a separate price to each customer the
maximum or reservation price they are willing to
pay. - Examples Professions, car dealers, private
universities
1817. Perfect First-Degree Price Discrimination
/Q
Without price discrimination, output is Q and
price is P. Variable profit is the area between
the MC MR (yellow).
Pmax
MC
P
D
MR
Quantity
Q
1918. Perfect First-Degree Price Discrimination
/Q
Consumer surplus is the area above P and
between 0 and Q output.
Pmax
MC
P
D AR
MR
Quantity
Q
2019. Perfect First-Degree Price Discrimination
/Q
Output expands to Q and price falls to PC where
MC MR AR D. Profits increase by the area
above MC between old MR and D to output Q
(purple)--no consumer surplus.
Pmax
MC
P
PC
D AR
MR
Quantity
Q
Q
2120. Perfect First-Degree Price Discrimination
/Q
Consumer surplus when a single price P is
charged.
Pmax
Variable profit when a single price P is
charged.
MC
P
Additional profit from perfect price
discrimination
PC
D AR
MR
Quantity
Q
Q
2221. Intertemporal Price Discrimination
- Separating the Market With Time
- Initial release of a product, the demand is
inelastic - Hard cover books
- New release movies
- Latest fashions
2322. Intertemporal Price Discrimination
- Separating the Market With Time
- Once this market has yielded a maximum profit,
firms lower the price to appeal to a general
market with a more elastic demand - Paper back books
- Dollar Movies
- Discount rack
2423. Peak-Load Pricing
- Demand for some products may peak at particular
times. - Rush hour traffic
- Electricity - late summer afternoons
- Ski resorts on weekends
2524. Peak-Load Pricing
- Capacity restraints will also increase MC.
- Increased MR and MC would indicate a higher
price. - MR is not equal for each market because one
market does not impact the other market.
2625. Peak-Load Pricing
/Q
MC
D1 AR2
MR1
Quantity
2726. Peak-Load Pricing
MC
/Q
Peak-load price P1 .
P1
D1 AR2
MR1
Quantity
Q1
2827. Peak-Load Pricing
Off- load price P2 .
/Q
MC
P1
D1 AR2
P2
MR1
D2 AR2
MR2
Quantity
Q1
Q2