PRICING POLICY

IMBA Managerial Economics

Jack Wu
NORTHWEST AIRLINES
MINNEAPOLIS-NEW YORK

Business class $ 1711

Unrestricted $ 1267
economy
Advance purchase, $ 765
with penalties
Advance purchase, $ 692
for senior
EMIRATES AIRLINE, DUBAI-MUMBAI,
ECONOMY CLASS, MAY 2004

Fare Restrictions Price

Year KRTAE1 None AED 2250

(US$ 613)

Special Excursion Min. 7 days, max. 4 mths AED 1900

QEE4MAE1 stay

Basic Season Special Low season; min. 7 days, AED 1550

Excursion LLE4MAE1 max. 4 mths stay

Basic Season Special Low season; min. 7 days, AED 1200

Excursion VLE4MAE1 max. 4 mths stay
EMIRATES AIRLINE, MUMBAI-DUBAI,
ECONOMY CLASS, MAY 2004

Fare Restrictions Price

Economy unrestricted None INR 25,600

LRT (US$ 557)

Economy restricted None INR 22,700

LRTIN1

Regular Excursion Min. 7 days, max. 3 INR 20,100

LEE3M1 mths stay

Special Excursion Max. 3 mths stay. INR 17,000

VEE3MIN1
EMIRATES AIRLINE
 Why does Emirates charge lower fare for passengers
originating from Mumbai?
 How is this discrimination possible?
PRICING POLICY
 uniform pricing
 complete price discrimination

 direct segment discrimination

 indirect segment discrimination

 bundling
UNIFORM PRICING
Price (Thousand Yen per unit)

80

55

marginal cost
30

marginal revenue demand

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
buyer surplus
potential buyer

potential buyers

price

marginal
cost

0
quantity
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

Price (Thousand Yen per unit)

Price (Thousand Yen per unit)

80 demand

55 50
marginal marginal
40
revenue marg. cost
30 cost 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?

 ASIAN WALL STREET JOURNAL

Price for annual subscription, May 2006

Print: Hong Kong (HK$ 2,700) US$ 348

Print: Singapore (S$ 525) US$ 331
Print: Tokyo (Yen 94,500) US$ 845
Interactive: Worldwide US$ 99

 Why different prices for print edition but not

interactive edition?
INDIRECT SEGMENT DISCRIMINATION
 structure choice to earn different incremental margins
from each segment
 implementation
 sellercontrols some variable to which segments are
differentially sensitive
 buyers cannot circumvent the variable
AIR TRAVEL: BENEFITS

Unrestricted Restricted
Traveler Segment Travel ($) Travel ($)
Maria Business 1000 200
Tom Business 900 180
Robin Vacation 500 400
Leslie Vacation 280 224
 AIR TRAVEL: INDIRECT SEGMENT
DISCRIMINATION

Total Total
Fare Rev. Cost Profit
Product ($) Sales ($) ($) ($)
Unrestrict 900 2 1800 400 1400
ed
Restricted 399 1 399 200 199

*MC=200
CHINESE EMBASSY: VISA FEES

Application period

1 day 3 days 7 days

Single entry $75 $60 $25

Double entry $85 $70 $35

 PRICING POLICIES: RANKING

Profitability Policy Information

Requirement
Highest Complete price Highest
discrimination
Direct segment
discrimination
Indirect segment
discrimination
Lowest Uniform pricing Lowest
BUNDLING
 strategy
 purebundling
 mixed bundling
CABLE TELEVISION: BENEFITS

“if every segment … was wild about one

thing and hated the rest, they have done
their job” (Economist)

Segment Education Music

channel channel
Conservatives $20 $2

Middle of road $11 $11

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
DISCUSSION QUESTION
 (A)Suppose that the marginal cost of the cable company
providing a channel to the household is 0. Will you
provide all channels to all types of household from the
efficiency perspective? What is your profit-maximizing
pricing strategy?
 (B)Suppose that the marginal cost of the cable company
providing a channel to the household is 50. Will you
provide all channels to all types of household from the
efficiency perspective? What is your profit-maximizing
pricing strategy?