Managerial Economics Jack Wu

Pricing Policy uniform pricing complete price discrimination direct segment discrimination indirect segment discrimination bundling

Northwest Airlines Minneapolis-New York

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marginal revenue marginal cost demand Quantity (Units a year) Price (Thousand Yen per unit) Uniform Pricing

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 potential buyer

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%)

Quantity (Units a year) Price (Thousand Yen per unit) (a) Men’s demand Quantity (Units a year) Price (Thousand Yen per unit) (b) Women’s demand marginal revenue demand marginal revenue demand marginal cost Direct Segment Discrimination, III marg. cost

NYNEX Telephone Service New York City residential -- $16/month business -- $23/month How is discrimination possible?

Indirect Segment Discrimination structure choice to earn different incremental margins from each segment implementation seller controls some variable to which segments are differentially sensitive buyers cannot circumvent the variable

Air Travel: Benefits

*MC=200 Air Travel: Indirect Segment Discrimination

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Pricing Policies: Ranking

Bundling strategy pure bundling mixed bundling

Cable Television: Benefits

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