Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Chapter 11 Creative Pricing Schemes

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Introduction Consumers encounter many different pricing styles.  i.e. Senior Citizen discounts at movie theatres.  i.e. Paying for oversized candy bars and not paying to use the restroom. Price discrimination: the act of changing different prices to different people

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Purpose of the Chapter A firm can substantially increase its profits by developing a clever pricing method; some of the pricing schemes discussed in this chapter are:  All-or-Nothing Pricing  Two-Part Pricing  Second-Degree Price Discrimination  Third-Degree Price Discrimination  Bundling  Required Tie-In Sales

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Striving for an Unhappy Customer The more money you get from your customers, the more money you make and the less happy is the customer.  i.e. Mary has a bull to sell. Darlene has $1500 to use to buy a bull. Mary sells Darlene a bull for $1000. This leaves Darlene with $500, this makes her very happy. But if Mary was to sell Darlene a bull for $1450. This would leave Darlene with $50, making her unhappy.  This is what we are striving for. To maximize our profits and still make the customer slightly happy.

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Figure Per Consumer Demand Curve

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Figure Per Consumer Demand Curve

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. First-Degree or Perfect Price Discrimination First-Degree Discrimination: Take each consumer and sell her individual units at a time. Set the price equal to her maximum willingness-to-pay for each unit, continue selling her units and keep changing the maximum willingness-to-pay for each unit. Do this until her maximum willingness-to-pay is less than the marginal cost of production. This will continue until there is no profits being earned.

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. All-or-Nothing Pricing All-or-Nothing Pricing: the consumer either purchases a specific number of units at a price or no units.  Refer to Figure 11.1 This pricing scheme would maximize the consumer’s willingness-to-pay. You would sell all four units together at the price of A + B+ C + D + E + F + G + H The cost of production would be B + D + F + H The profits would be A + C + E + G This is the maximum profits possible.

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Figure Example of All-Or-Nothing Pricing

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Two-Part Pricing Two-Part Pricing: the consumer is charged a lump-sum fee plus a price for each unit purchased.  i.e. Going to the movies: Buy a ticket to get in the movies Buy popcorn, candy, or drink separate.  i.e. Sam’s Club Buy a membership to shop Buy individual items separate.

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Figure Example of Two-Part Pricing

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Second-Degree Price Discrimination Second-Degree Price Discrimination: involves offering discounts to consumers who purchase more units of a good.  i.e. Senior Citizen discounts for coming to a restaurant early.

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Figure Perfect Price Discrimination (via All-Or-Nothing Pricing) With Different Consumer Types

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Third-Degree Price Discrimination Third-Degree Price Discrimination: involves charging consumers with different demand elasticities different prices.  The milk market orders acting as a monopoly and setting prices for milk depending on which region it is being sold.

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Source: United States Department of Agriculture Figure Federal Milk Marketing Order Areas

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Third-Degree Price Discrimination Example: Group 1 has an elastic demand and Group 2 has an inelastic demand  Group 2, with a more inelastic demand, is charged a higher price. Figure Third-Degree Price Discrimination

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. When Third-Degree Price Discrimination Works Conditions for Third-Degree Price Discrimination:  Firm can identify and separate all consumers into distinct groups.  Reselling between groups is prevented  The different groups have different elasticities of demand.  Must be able to avoid prosecution by antitrust authorities.

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Bundling Bundling: Selling two or more goods together at a single price.  Reservation prices: maximum willingness-to-pay.  Example of Bundling: One company selling a herbicide and an insecticide together instead of individually. Reservation Price for Herbicide Reservation Price for Insecticide Reservation Price for a bundle of herbicide and insecticide Farmer Tina Turner $100$50$150 Farmer Ike Turner $120$40$160 Figure Bundling Example

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Required Tie-In Sales Tie-in Sale: consumers are forced to purchase one good before purchasing another.  Required Tie-In Sale: where a purchase commits the consumer to also buy complementary goods from the same firm. i.e. To open your own Wendy’s franchise, you have to buy the franchise and buy the food supply from Wendy’s.

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Figure Requirement Tie-In Sales Example

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Figure Requirement Tie-In Sales Example Continued

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Figure Requirement Tie-In Sales Example Outcome