Special Pricing Practices Price discrimination Joint-product pricing Transfer pricing

Monopoly Pricing Price discrimination First degree Second degree Third degree 1st degree price discrimination. Perfect price discrimination--if the monopolist is aware of the maximum price that every customer is willing to pay, it is possible for the monopolist to extract all of the consumer surplus by charging each consumer the maximum amount the he is willing to pay for each unit. Used by private universities to set financial aid. 2nd degree price discrimination. Discrimination across submarkets via a pricing structure based on volume discounts. This type of pricing arrangement (used by utility companies) allows the monopolist to capture some of the consumer surplus. Block pricing. 3rd degree price discrimination. Charging different customers different prices based on elasticity of demand. To be successful, the monopolist must be able to (1) differentiate the market and (2) prevent arbitrage. Monopolist’s dilemma: 1. What Q for each market segment? 2. What P for each? The optimal allocation between categories will be where MR1 = MR2 = MC. P1(1 - 1/EP1) = P2(1 - 1/EP2) P1/P2 = (1 - 1/EP2)/(1 - 1/EP1) It will not pay to discriminate if EP1 = EP2. Price will be lower to the category of customers that has the higher price elasticity.

Pricing Multiple Products Pricing related products Joint products in fixed proportions Joint products in variable proportions* Q = QA + QB TR = PA QA + PBQB MRA = change in TRA wrt QA plus change in TRB wrt QA MRB = change in TRA wrt QB plus change in TRB wrt QB If A and B are complements, then change in TRB wrt QA is positive. By increasing the sales of product A, the TR from product B increases. Likewise, if A and B are substitutes, the term is negative.

Transfer Pricing With no external market Perfectly competitive external market Imperfectly competitive external market* Transfer price with no external market => the division producing the intermediate product can only sell it internally. Assume that it takes one unit of the intermediate product to produce one unit of the final product; Q1 = Q2. Transfer price with perfectly competitive external market => Q1 and Q2 are no longer required to equal to each other. The situation can be one of either excess internal demand or excess internal supply. Transfer price with perfectly competitive external market. This assumes that the intermediate product is not identical across firms. Demand curves in the intermediate market are downward sloping.

Pricing in Practice Cost-plus pricing Mark-up pricing Price elasticity Concept is deceptively simple. Firms set price equal to average total cost plus a percentage mark-up over average total cost. P = AC + (m x AC) = AC (1 + m) Criticisms: 1. Uses AC rather than MC 2. Does not incorporate MR into decision Cost-plus pricing can approximate MR = MC pricing. MR = P(1 + 1/EP) P = MR/[(1 + 1/EP) = MR/[(EP/ EP) + 1/EP] = MR/[(EP + 1)/EP] = MR x [EP /(EP + 1)] Since profit maximization => MR = MC P = MC x [EP /(EP + 1)] assuming CRS => MC = AC P = AC x [EP /(EP + 1)] AC(1 + m) = AC x [EP /(EP + 1)] 1 + m = EP /(EP + 1) m = [EP /(EP + 1)] - 1

International Issues Domestic v. foreign pricing Dumping Nothing more than price discrimination. How do you define dumping?