MONASH

BUSINESS

ECW2731Managerial Economics

Lecture 9
 Pricing Rules-of-Thumb

There are clear and easy rules to determine optimal

prices in both:
Perfectly competitive markets
Imperfectly competitive markets
Monopoly
Oligopoly
Monopolistic competition
Pricing Rules-of-Thumb
 Pricing Rules-of-Thumb

2
Pricing Rules-of-Thumb
 Price Discrimination

Profit-Making Criteria
Product valuation differs across consumers.
Price elasticity of demand must differ in submarkets.
The firm must have ability to prevent reselling.
 Degrees of Price Discrimination

First degree (Perfect Price Discrimination)

o The firm is aware of each buyer’s demand curve
o Creates different prices for each customer (maximum profits).
Second degree (bulk discount)
o Gives quantity discounts.
o The firm charges a different price, depending on the quantity
each buyer purchases
Third degree (Groups)
o the firm breaks buyers into groups based upon their price
elasticity of demand
o assigns different prices by customer age, sex, income, etc.
(most common).
First Degree Price Discrimination(Perfect
Price Discrimination)

First degree creates different

prices for each customer (to
get maximum profits).
the firms aware of each
buyer’s demand curve
Each consumer is charged the
price he/she is willing to pay.
Producer takes all the
consumer surplus
First Degree Price Discrimination(Perfect
Price Discrimination)

The price charged to each

consumer = the price consumer
is willing to pay
 Second Degree Price Discrimination
(Non-linear Pricing)

Different price is charged for a different quantity

bought (but not across consumers).
o set one price for a 1st bundle, a lower price for a 2nd
bundle, ....
o extract some, but not all of consumer surplus
Note:
o In 1st degree case=>different prices charged for different
consumers
o In 2nd degree case=>different prices charged for different
quantities (for same consumer)
 Second Degree Price Discrimination
(Non-linear Pricing)

Examples:
Telephone companies charging different prices for
different quantities.
Useful if there are economies of scale
See next slide : Downward sloping AC , Q2 and Q3
are profitable with discrimination. They take
advantage of the scale economies and so offer
lower price P2 and P3 .
 Second Degree Price Discrimination

$/Q Different prices are Without discrimination: P

charged for different = P0 and Q = Q0. With
P1 quantities or second-degree
“blocks” of same discrimination there are
P0 good. three blocks with prices
P1, P2, & P3.

P2
AC
P3
MC

D
MR
Q1 Q0 Q2 Q3 Quantity
1st Block 2nd Block 3rd Block
 Active Learning Activities: Question 3

a. Does second-degree price discrimination work in

the real world? Explain.
b. Is second-degree price discrimination efficient?
 Price Discrimination:
Price-Output Determination
 Price Discrimination:
Price-Output Determination

The athletic department has two options to maximize profits (minimize loss).
1.

1. To set discriminated prices for students and general public.

2. To set a common price for all customers.
 Price Discrimination:
Price-Output Determination

QP + QS
Price Discrimination: One Price Alternative
Price Discrimination: One Price Alternative
 Price Discrimination:
Price-Output Determination

PP = 850 – 0.01QP
PP = 850 – 0.01(0) = 850
PP = 850 – 0.01(20,000) = 650
 Price Discrimination:
Price-Output Determination
Price Discrimination: One Price Alternative

QP = 85,000 - 100PP
QS = 80,000 - 400PS
Q = QP + QS

QP = 85,000 – 100(200) = 65,000

QS = 80,000 – 400(200) = 0
Q = 65,000 + 0 = 65,000

QP = 85,000 – 100(180) = 67,000

QS = 80,000 – 400(180) = 8,000
Q = 65,000 + 8000 = 75,000
Price Discrimination Example
 Two-Part Pricing

One-price Policy and Consumer Surplus

o A single price policy creates bargains for avid buyers;
they enjoy consumer surplus.
o Consumer surplus reflects unpaid benefit.
Capturing Consumer Surplus With Two-part Pricing
o Lump-sum charges plus user fees capture consumer
surplus for producers, Used for “membership
organizations” e.g., golf clubs.
Two-Part Pricing
Two-Part Pricing
One-Price Policy and Consumer
Surplus
One-Price Policy and Consumer
Surplus
 Capturing Consumer Surplus with Two-Part
Pricing
The profit-maximizing two part pricing practice is to charge an
annual membership fee of $3,200 per year plus greens fees of $20 per
round played.
Total revenue = $3,200 + ($20 x 80) = $4,800
Total Cost = 20Q = 20(80) = $1,600
Two part pricing Profit = TR – TC
= $4,800 - $1,600
= $3,200

Alternative formula
Profit = (P – ATC)Q
 Multiple-product Pricing

Demand Interrelations
o Arise because of substitute or complementary relations
among various products or product lines.
o Cross-marginal revenue terms indicate how product
revenues are related to another.

Complementary product ➔ net effect is positive

Substitute product ➔ net effect is negative
 Multiple-product Pricing

Production Interrelations
o Joint products may compete for resources or be
complementary.
o A by-product is any output customarily produced as a
direct result of an increase in the production of some other
output.
Joint Products
Joint Products – fixed proportions
Joint Products
Joint Products without Excess By-
Product
Joint Products without Excess By-
Product
Joint Products without Excess By-
Product
Joint Products without Excess By-
Product
Joint Products without Excess By-
Product
Joint Products with Excess By-Product
Joint Products with Excess By-Product
Joint Products with Excess By-Product
(Dumping)
Joint Products with Excess By-Product
(Dumping)
Joint Products with Excess By-Product
(Dumping)