L ECTURE N INE : P RICING IPEM Tohoku University Managerial Economics Lecturer : Jack Wu Period 1 & 2 /February 18

E MIRATES A IRLINE, D UBAI -M UMBAI, E CONOMY CLASS, M AY 2004 FareRestrictionsPrice Year KRTAE1NoneAED 2250 (US$ 613) Special Excursion QEE4MAE1 Min. 7 days, max. 4 mths stay AED 1900 Basic Season Special Excursion LLE4MAE1 Low season; min. 7 days, max. 4 mths stay AED 1550 Basic Season Special Excursion VLE4MAE1 Low season; min. 7 days, max. 4 mths stay AED 1200

E MIRATES A IRLINE, M UMBAI -D UBAI, E CONOMY CLASS, M AY 2004 FareRestrictionsPrice Economy unrestricted LRT NoneINR 25,600 (US$ 557) Economy restricted LRTIN1 NoneINR 22,700 Regular Excursion LEE3M1 Min. 7 days, max. 3 mths stay INR 20,100 Special Excursion VEE3MIN1 Max. 3 mths stay.INR 17,000

E MIRATES A IRLINE Why does Emirates charge lower fare for passengers originating from Mumbai? How is this discrimination possible?

P RICING P OLICY uniform pricing complete price discrimination direct segment discrimination indirect segment discrimination bundling

marginal revenue marginal cost demand Quantity (Units a year) Price (Thousand Yen per unit) UNIFORM PRICING

U NIFORM P RICING : P ROFIT M AXIMUM 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

P RICE E LASTICITY 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

P RICING P RIVATE -L ABEL C OLA 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?

S HORTCOMINGS U NIFORM P RICING : S HORTCOMINGS leaves buyers with a lot of surplus does not sell to every potential buyer marginal cost price buyer surplus potential buyers $ 0 quantity

C OMPLETE P RICE D ISCRIMINATION 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

C OMPLETE P RICE D ISCRIMINATION : P RACTICE bargaining auctions

D IRECT S EGMENT D ISCRIMINATION, I price by segment implementation  fixed identifiable characteristic --- basic for segmentation  no re-sale

D IRECT S EGMENT D ISCRIMINATION, 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 T ELEPHONE S ERVICE New York City residential -- $16/month business -- $23/month How is discrimination possible?

A SIAN W ALL S TREET J OURNAL Price for annual subscription, May 2006 Print: Hong Kong (HK$ 2,700)US$ 348 Print: Singapore (S$ 525)US$ 331 Print: Tokyo (Yen 94,500)US$ 845 Interactive: WorldwideUS$ 99  Why different prices for print edition but not interactive edition?

I NDIRECT S EGMENT D ISCRIMINATION 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

C HINESE E MBASSY : V ISA F EES Application period 1 day3 days7 days Single entry$75$60$25 Double entry$85$70$35

PRICING POLICIES: RANKING

B UNDLING strategy pure bundling mixed bundling

C ABLE T ELEVISION : B ENEFITS

P URE OR M IXED B UNDLING What is the profit-maximizing pricing policy if marginal cost per channel = 0 marginal cost per channel = $5

P URE OR M IXED B UNDLING 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