The Economic Way of Thinking 10e ©Prentice Hall “The Economic Way of Thinking” 10 th Edition by Paul Heyne, Peter Boettke, and David Prychitko “Price Searching” PowerPoint Slides prepared by Assistant Professor Paul Harris Camden County College

The Economic Way of Thinking 10e ©Prentice Hall Chapter Outline I.Introduction II.The Popular Theory of Price Setting III.Introducing Ed Sike IV.The Basic Rule for Maximizing Net Revenue V.The Concept of Marginal Revenue VI.Why Marginal Revenue Is Less Than Price

The Economic Way of Thinking 10e ©Prentice Hall Chapter Outline V11.The Basic Rule for Maximizing Net Revenue VIII.The Concept of Marginal Revenue IX.Why Marginal Revenue Is Less Than Price X.Setting Marginal Revenue To Equal Marginal Cost XI.What About Those Empty Seats?

The Economic Way of Thinking 10e ©Prentice Hall Chapter Outline XII.The Price Discriminator’s Dilemma XIII.The College As Price Searcher XIV.Some Strategies For Price Discrimination XV.Ed Sike Finds a Way XVI.Resentment and Rationale

The Economic Way of Thinking 10e ©Prentice Hall Chapter Outline XVII.Lunch and Dinner Prices XVIII.Cost Plus Markup Reconsidered XIX.Once Over Lightly

The Economic Way of Thinking 10e ©Prentice Hall Introduction Firms will produce an additional product as long as its marginal revenue is greater than its marginal cost.Firms will produce an additional product as long as its marginal revenue is greater than its marginal cost. Net RevenueNet Revenue –Total revenue - total costs Firms will produce an additional product as long as its marginal revenue is greater than its marginal cost.Firms will produce an additional product as long as its marginal revenue is greater than its marginal cost. Net RevenueNet Revenue –Total revenue - total costs

The Economic Way of Thinking 10e ©Prentice Hall The Popular Theory of Price Setting A Popular BeliefA Popular Belief –Selling price is cost plus markup. QuestionsQuestions –Why choose 25 versus a 50 percent markup? –Why will a firm vary its percentage markup depending upon various factors? –Why sell below average cost?

The Economic Way of Thinking 10e ©Prentice Hall The Popular Theory of Price Setting A Popular BeliefA Popular Belief –Selling price is cost plus markup. QuestionsQuestions –Why choose 25 versus a 50 percent markup? –Why will a firm vary its percentage markup depending upon various factors? –Why sell below average cost? The cost-plus argument has numerous faults. has numerous faults.

The Economic Way of Thinking 10e ©Prentice Hall Introducing Ed Sike Scenario –Ed Sike is a college sophomore. –He sells film tickets to earn spending money. –He sets the price for his tickets.

The Economic Way of Thinking 10e ©Prentice Hall Introducing Ed Sike Ed’s Bills Per Movie Film rental$1,800 Auditorium rental250 Operator50 Ticket takers 100 Total$2,200

The Economic Way of Thinking 10e ©Prentice Hall Introducing Ed Sike Scenario –Ed receives all revenue. –Auditorium seats 700 people.

The Economic Way of Thinking 10e ©Prentice Hall Introducing Ed Sike Ed’s Demand Schedule QuantityTotalNet PriceDemandedRevenueRevenue $ $2,100-$ $450

The Economic Way of Thinking 10e ©Prentice Hall Introducing Ed Sike Price Per Ticket Number of Tickets D

The Economic Way of Thinking 10e ©Prentice Hall Introducing Ed Sike Scenario –The student association will subsidize the films if they lose money. –Ed is expected to earn as much net revenue as possible.

The Economic Way of Thinking 10e ©Prentice Hall The Basic Rule for Maximizing Net Revenue Set the Price so that only those units whose marginal revenue is greater than marginal Costs. Marginal costs is the addition to total cost from selling an additional unit. Marginal revenue is the addition to total revenue from selling one more unit.

The Economic Way of Thinking 10e ©Prentice Hall $7300$2,100-$ , , , $3700$2, The Concept of Marginal Revenue Ed’s Demand Schedule QuantityTotalNet PriceDemandedRevenueRevenue

The Economic Way of Thinking 10e ©Prentice Hall The Concept of Marginal Revenue Marginal Revenue The additional revenue expected from an action under consideration. Ed’s marginal revenue is zero.

The Economic Way of Thinking 10e ©Prentice Hall The Concept of Marginal Revenue Ed’s Demand Schedule QuantityTotalNet PriceDemandedRevenueRevenue $7300$2,100-$ , , , $3700$2,

The Economic Way of Thinking 10e ©Prentice Hall The Concept of Marginal Revenue Question –Why is profit maximized where marginal revenue equals marginal cost?

The Economic Way of Thinking 10e ©Prentice Hall Why Marginal Revenue Is Less Than Price Marginal revenue < Price Why? In order to increase sales, Ed must lower the price on the additional ticket and the ones that would have been sold at a higher price.

The Economic Way of Thinking 10e ©Prentice Hall Why Marginal Revenue Is Less Than Price Marginal revenue The difference between the revenue gained from additional quantity and the revenue lost from lowering price on the previous quantity

The Economic Way of Thinking 10e ©Prentice Hall Gained Lost Why Marginal Revenue Is Less Than Price P Q D A B

The Economic Way of Thinking 10e ©Prentice Hall Additions to net revenue Subtractions from net revenue Why Marginal Revenue Is Less Than Price P Q MR MC

The Economic Way of Thinking 10e ©Prentice Hall Why Marginal Revenue Is Less Than Price QuestionsQuestions –What would Ed have to do to sell 550 tickets instead of 500? –How would this impact his marginal revenue? –Is it a correct pricing decision?

The Economic Way of Thinking 10e ©Prentice Hall Why Marginal Revenue Is Less Than Price P Q MR

The Economic Way of Thinking 10e ©Prentice Hall Setting Marginal Revenue To Equal Marginal Cost  Question  What would happen if the distributor changed the rental fee to $800 + $2/ticket sold?

The Economic Way of Thinking 10e ©Prentice Hall Setting Marginal Revenue To Equal Marginal Cost P Q MR D Marginal cost What is Ed’s net revenue now?

The Economic Way of Thinking 10e ©Prentice Hall What About Those Empty Seats? QuestionsQuestions –Aren’t seats going to waste? –Why doesn’t Ed lower the price on the empty seats?

The Economic Way of Thinking 10e ©Prentice Hall The Price Discriminator’s Dilemma QuestionQuestion –When should Ed leave seats empty? AnswerAnswer –If the cost of discriminating among potential ticket buyers is greater than the additional revenue gained through discrimination

The Economic Way of Thinking 10e ©Prentice Hall The Price Discriminator’s Dilemma Question What if Ed offered to sell the empty seats for $3 to anyone unwilling to pay more?

The Economic Way of Thinking 10e ©Prentice Hall The College As a Price Searcher QuestionsQuestions –Why do colleges continually ask for donations to cover costs not paid for by tuition? –Why do these colleges give scholarships to needy students?

The Economic Way of Thinking 10e ©Prentice Hall Demand Curve for Enrollment at Ivy College Q MR 0 5,0003,0001,0004,0002,000 1,000 3,000 4,000 5,000 6,000 2,000 D Assume MC = 0 Students enrolling (per year) 6,000 Annual Tuition/Student 0

The Economic Way of Thinking 10e ©Prentice Hall The College As a Price Searcher Questions How could Ivy charge $6,000 and give each student a scholarship equal to the difference between $6,000 and what the student is willing to pay? How does the school determine what each student is willing to pay?

The Economic Way of Thinking 10e ©Prentice Hall The College As a Price Searcher Solutions Willingness to pay is correlated with wealth. Scholarships are available to those who fill out some forms. Ivy could discriminate based on wealth to increase revenue.

The Economic Way of Thinking 10e ©Prentice Hall Scholarships enrolled Tuition Paid Revenue has increased from $9m to $18m. The College As a Price Searcher P Q 6,000 D

The Economic Way of Thinking 10e ©Prentice Hall Some Strategies for Price Discrimination Grocery Coupons Discounts for: ChildrenStudents Senior citizens Airfare Prices Business traveler Vacationer

The Economic Way of Thinking 10e ©Prentice Hall Some Strategies for Price Discrimination P Q Business Traveler P Q D D Vacation Traveler

The Economic Way of Thinking 10e ©Prentice Hall Ed Sike Finds A Way Questions Could Ed increase revenue by charging different groups of customers different prices? Should students or teachers pay the higher price?

The Economic Way of Thinking 10e ©Prentice Hall Ed Sike Finds A Way Price Per Ticket Number of Tickets D faculty MR faculty DsDs MR s

The Economic Way of Thinking 10e ©Prentice Hall Resentment and Rationale Firms must justify price discrimination. Conditions Necessary for Price Discrimination Distinguish buyers with different price elasticities Prevent low-price buyers from reselling to high-price buyers Control resentment

The Economic Way of Thinking 10e ©Prentice Hall Resentment and Rationale QuestionQuestion –Why would a ticket from New York to Chicago cost more than a ticket from New York to Los Angeles? QuestionQuestion –Why would a ticket from New York to Chicago cost more than a ticket from New York to Los Angeles?

The Economic Way of Thinking 10e ©Prentice Hall Resentment and Rationale P Q D Chicago D LA

The Economic Way of Thinking 10e ©Prentice Hall Lunch and Dinner Prices QuestionQuestion –Why are lunch prices more expensive than dinner prices?

The Economic Way of Thinking 10e ©Prentice Hall Lunch and Dinner Prices AnswerAnswer –Lunch customers are more responsive to prices. They eat out more.They eat out more. The meal makes up a large share of the event’s cost (no sitter, movie, etc.).The meal makes up a large share of the event’s cost (no sitter, movie, etc.).

The Economic Way of Thinking 10e ©Prentice Hall Cost Plus Markup Reconsidered Price Searchers:Price Searchers: 1)Estimate marginal cost and marginal revenue. 2) Determine the appropriate level of output. 3) Set their prices so that they can just manage to sell the output produced. `

The Economic Way of Thinking 10e ©Prentice Hall Cost Plus Markup Reconsidered Cost-Plus MarkupCost-Plus Markup –A good place to start Cost-Plus MarkupCost-Plus Markup –A good place to start

The Economic Way of Thinking 10e ©Prentice Hall Once Over Lightly Price searchers are looking for pricing structures that will enable them to sell all units for which MR>MC. A crucial factor for a price searcher is the ability or inability to discriminate. The crucial rule for price searching is to set MR= to MC.

The Economic Way of Thinking 10e ©Prentice Hall End of Chapter 10 Next. Chapter 11, “ Competition and Government Policy”