Pricing strategies and practices

What prices should be set?

Price discrimination.

Multiple and joint product pricing.

Transfer pricing

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 Pricing strategies and practices

Price discrimination.

Where a firm exercises market power, the

opportunity may exist to further increase
profits by charging different prices to different
consumers, or to different groups of
consumers for reasons other than costs

In so doing the firm will appropriate all or part of

the consumer surplus.

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 Pricing strategies and practices

Price discrimination.

Types of price discrimination

 First-degree: the firm is aware of each buyer’s
demand curve
 Second-degree: the firm charges a different price,
depending on the quantity each buyer purchases
 Third-degree: the firm breaks buyers into groups
based upon their price elasticity of demand

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 Pricing strategies and practices

Price discrimination.

First Degree Price Discrimination

(Perfect Price Discrimination)

 Each consumer is charged the price he/she is willing to

pay.

 Producer takes all the consumer surplus

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 Pricing strategies and practices

Price discrimination.

1st. degree price discrimination

Price

P1

PL
Demand

Q1 Q Quantity
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 Pricing strategies and practices

Price discrimination.

1st. degree price discrimination

Price

P1
P2

PL
Demand

Q1 Q2 Q Quantity
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 Pricing strategies and practices

Price discrimination.

1st. degree price discrimination

Price

P1
P2
P3

PL
Demand

Q1 Q2 Q3 Q Quantity
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 Pricing strategies and practices

Price discrimination.

1st. degree price discrimination

For each consumer
Price price charged=price
willing to pay
P1
P2
Monopolist
P3
P4
appropriates all
. consumer surplus
.
PL
Demand

Q Quantity
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 Pricing strategies and practices

Price discrimination.

2nd Degree Price Discrimination

(non-linear pricing)
 Different price is charged for a different
quantity bought (but not across consumers).
 set one price for a 1st bundle, a lower price
for a 2nd bundle, ....
 extract some, but not all of consumer surplus

Note:
In 1st deg case=>different prices charged for
different consumers
In 2nd deg case=>different prices charged for
different quantities (for same consumer)

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 Pricing strategies and practices

Price discrimination.

2nd Degree Price Discrimination

(non-linear pricing)

 Examples:
Telephone companies charging different prices for
different quantities

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 Pricing strategies and practices

Price discrimination.

3rd Degree Price Discrimination

P P
MC

D2 DT

D1 MR2 MRT
MR1

Q Q QT Q
Market1 Market 2 Mkt1&Mkt2
steeper D flatter D Q =Q +Q
T 1 2

less elastic more elastic

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 Pricing strategies and practices

Price discrimination.

3rd Degree Price Discrimination

:
P P
MC

D2 DT

D1 MR2 MRT
MR1

Q Q QT Q
Market 2 Mkt1&Mkt2
Market1
Q =Q +Q
T 1 2

How much to sell in each Mkt (Q ? Q) ? what prices (P ? P )?

1 2 1 2

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 Pricing strategies and practices

Price discrimination.

3rd Degree Price Discrimination

P P
MC

D2 DT

D1 MR2 MRT
MR1

Q 1 Q Q 2 Q QT

Market1 Market 2 Mkt1&Mkt2

MR1=MC MR2=MC QT=Q1+Q2
Less elastic More elastic MR1=MR2=MC
demand demand

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 Pricing strategies and practices

Price discrimination.

3rd Degree Price Discrimination

P P
MC
P
1
P 2
DT
D2
D1 MR2 MRT
MR1

Q 1 Q Q 2 Q QT

Market1 Market 2 Mkt1&Mkt2

MR1=MC MR2=MC QT=Q1+Q2
Less elastic More elastic MR1=MR2=MC
Demand - Demand -
Lower price Higher Price
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 Pricing strategies and practices

Multiple-product Pricing
 Demand Interrelations
• Cross‑marginal revenue terms indicate how
product revenues are related to another.
 Production Interrelations
• Joint products may compete for resources or be
complementary.
• A by-product is any output customarily produced
as a direct result of an increase in the production
of some other output.
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 Pricing strategies and practices

Joint Products in Variable proportions

 Joint Products in Variable Proportions

 If products are produced in variable proportions,
treat as distinct products.
 For joint products produced in variable
proportions, set MRA=MCA and MRB=MCB.
 Common costs are joint product expenses.
 Allocation of common costs is wrong and arbitrary.
 Joint Products in Fixed Proportions
 Some products are produced in a fixed ratio.
 If Q=QA=QB, set MRQ=MRA+MRB=MCQ. 16
 Pricing strategies and practices

Joint product pricing.

Joint products produced in fixed proportions:

Some products are

produced in a fixed ratio

Q=QA=QB
MRT=MRA +MRB =MCQ

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 Pricing strategies and practices

Transfer pricing

Transferring an intermediate product from one

division to another in a vertically integrated firm

• Financial autonomy of divisions

• Marginal cost – opportunity cost

• Three cases
• Products Without External Markets
• Products With Competitive External Markets
• Products With Imperfectly Competitive External
Markets
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 Pricing strategies and practices

Transfer pricing

No external markets

• Financial autonomy of divisions

• Economic profit of one division is a cost of
another division.
• Profit can’t be made
• Pricing at marginal cost – covering opportunity
costs.

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 Pricing strategies and practices

Transfer pricing

There is an external market alternative

• Financial autonomy of divisions

• Two cases
• The external market is perfectly competitive
• Pricing at the external market price
• The external market is not perfectly
competitive
• Pricing at the marginal revenue of the
combined external and internal markets
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