Class 9

Pricing Models Cost Plus Pricing Price Discrimination Peak Load Pricing Transfer Pricing

Cost Plus Pricing Price = AVC + % Mark up Price = (1+m)*AVC However: –If AVC varies with output, the firm needs to know its output level before it can determine its price –Also, it does not imply price stability if costs are themselves changing, or if there are demand fluctuations

Cost plus pricing is equal to profit maximizing pricing if AVC is approximately constant and mark up is set to a value The more price inelastic the demand, the larger mark up is required for profit max. When competition is high, PED is likely to be hgh in which mark up is small Mathematical derivation in the text.

Price Discrimination Discounts for student or senior citizens Buy two, get one free Phone companies charge different rates to businesses vs. households. Journals charge different rates to individual subscribers vs. libraries. Cellular phone companies charge differently depending on the # of minutes you plan to talk. Reward-the-planned discrimination Usually tickets that are purchased in advance have lower price

Make-them-pay-for-the-label discrimination Toyota Corolla and GEO Prizm come off the same production line, but have different prices. Is this really pricE discrimination - charging different prices for the same product? Consumers receiving the label gain status and prestige. Is it the physical characteristics of a good or its label that determines whether it is the same product? Keep-them-in-their-zones discrimination Prices change between different neighborhoods within the same city. Sort-by-value-of-time discrimination Producers supply coupons or rebates to consumers willing to spend the extra time needed to find and clip them. Sort-by-eagerness discrimination Hardcover books vs. paperbacks. End-of-season sales.

Types of Price Discrimination First degree price discrimination: Price per unit of output depends o the identity of the purchaser and the number of units purchased Second degree price discrimination: Price depends on the number of units purchased Third degree price discrimination: Price depends on the identity of the purchaser

First Degree Price Discrimination The condition where market demand function represents a large number of consumers Eachone either buys one unit of good or abstains from buying alltogether Reservation price: Maximum price the consumer is willing to pay

Figure 10.1 First-degree price discrimination

The outcome is superior on allocative efficiency criteria for the following reasons: –in the non discriminating case, it is possible to make someone better off without making anyone worse off because there is a consumer who is willing to pay a price for extra unit that would exceed the cost of producing this extra unit –With first degree price disc. İt is not possible to make someone better off withput making anyone worse off

Second Degree Price Disc. It may not be practical to distinguish between individuals. Therefore distinguish by groups and charge depending on the units sold.

Figure 10.2 Second-degree price discrimination (two-part tariff)

Third Degree Price Discrimination The monopolist charges different groups of customers different prices. Price does not depend on units sold.

Figure 10.3 Third-degree price discrimination

Peak Load Pricing Demand varies Peak times and off peak periods

Figure 10.5 Peak-load pricing: full capacity production in both periods