1. © 2010 Pearson Education CanadaChapter 8 - 1 Chapter 8 Pricing for Profits © 2010 Pearson Education Canada

2. Chapter 8 - 2 Pricing for Profits Marginal Revenue & Marginal Cost

3. © 2010 Pearson Education CanadaChapter 8 - 3 LEARNING OBJECTIVES 8.1Define marginal revenue and explain how it depends on market structure and when it differs from price 8.2Explain when marginal cost increases and when it is constant as a business increases output 8.3Explain quantity and price decisions in the recipe for maximum profits, and show the importance of marginal revenue and marginal cost continued…

4. © 2010 Pearson Education CanadaChapter 8 - 4 8.4Define price discrimination and explain how it leads to higher profits by taking advantage of differences in elasticity of demand

5. © 2010 Pearson Education CanadaChapter 8 - 5 IS THE PRICE YOU SEE THE REVENUE YOU GET? MARGINAL REVENUE Marginal revenue equals price for price takers and is less than price for price makers. Smart businesses choose actions when marginal revenue is greater than marginal cost.

6. © 2010 Pearson Education CanadaChapter 8 - 6 MARGINAL REVENUE Marginal revenue additional revenue from selling one more unit or from extension of sales Fixed costs (sunk costs) do not change with changes in quantity of output Marginal revenue depends on – market structure (how competitive industry is) – whether business is price taker or price maker – marginal revenue equals price for price-taking businesses in extreme competition continued…

7. © 2010 Pearson Education CanadaChapter 8 - 7 – Marginal revenue less than price for price-making businesses in other market structures One-price rule products easily resold have single price in market – when price-making business lowers price, must lower price on all units sold, not just new sales – reason why marginal revenue less than price for price makers

8. © 2010 Pearson Education CanadaChapter 8 - 8 Figure 8.1 Calculating Marginal Revenues RowPrice Quantity Demanded Total Revenue Marginal Revenue A$200$ 0— B$181 C$162$32$14 D 3$42$10 E$124$48$6$6 F$105$50$2$2

9. © 2010 Pearson Education CanadaChapter 8 - 9 MARGINAL COST As output increases, marginal cost increases for businesses operating near capacity or when businesses’ additional inputs cost more. Marginal cost is usually constant for businesses not near capacity.

10. © 2010 Pearson Education CanadaChapter 8 - 10 RECIPE FOR PROFITS MARGINAL REVENUE > MARGINAL COST Smart business decisions for maximum profits: Quantity decision is produce all quantities for which marginal revenue is greater than marginal cost. Price decision is set highest price that allows you to sell that quantity.

11. © 2010 Pearson Education CanadaChapter 8 - 11 RECIPE FOR PROFITS For maximum profits, quantity decision first, then price decision – increase in quantity yields increase in profits if marginal revenue greater than marginal cost – stop increasing quantity when marginal revenue less than marginal cost Set highest price that allows sale of target quantity

12. © 2010 Pearson Education CanadaChapter 8 - 12 Figure 8.2 Paola’s MR & MC for Nose Piercings RowPriceQDQD Total Revenue Marginal Revenue Marginal Cost Impact on Profit A$200$000 B$181 $8+$10 C$162$32$14$8+ $6 D$143$42$10$8+ $2 E$124$48$ 6$8— $2 F$105$50$ 2$8— $ 6 G$ 86$48— $ 2$8— $10

13. © 2010 Pearson Education CanadaChapter 8 - 13 Figure 8.2 Paola’s MR & MC for Nose Piercings 20 15 10 5 0 -5 12345 -$2 $18 $10 $14 $8 $6 $2 MR MC MR MC MR MC MRMC MR MC MR MC MR, MC Q 6

14. © 2010 Pearson Education CanadaChapter 8 - 14 Figure 8.3 Paola’s Calculation of Profit for Nose Piercings RowPQDQD TRMRMC Impact on Profit Total Costs Total Profits A$200$ 0 $10 (Fixed Costs) — $10 (Losses) B$181 $ 8+ $10$18$ 0 C$162$32$14$ 8+ $ 6$26$ 6 D$143$42$10$ 8+ $ 2$34$ 8 E$124$48$ 6$ 8— $ 2$42$ 6 F$105$50$ 2$ 8— $ 6$50$ 0 G$ 86$48-$ 2$ 8— $10$58 — $ 8 (Losses)

15. © 2010 Pearson Education CanadaChapter 8 - 15 DIVIDE AND CONQUER PRICE DISCRIMINATION FOR HIGHER PROFITS Price discrimination divides customers into groups. Businesses increase profits by lowering price to attract price-sensitive customers (elastic demanders), without lowering price to others (inelastic demanders).

16. © 2010 Pearson Education CanadaChapter 8 - 16 PRICE DISCRIMINATION FOR HIGHER PROFITS Price discrimination charging different customers different prices for same product/service Price discrimination breaks one-price rule, possible only when business can – prevent low-price buyers from reselling to high-price buyers – control resentment among high-price buyers continued…

17. © 2010 Pearson Education CanadaChapter 8 - 17 Most price discrimination in services which cannot easily be resold continued…

18. © 2010 Pearson Education CanadaChapter 8 - 18 Price discrimination increases profits by – charging lower price to elastic demanders (lower willingness to pay) – charging higher price to inelastic demander (higher willingness to pay) Price-discriminators estimate marginal revenues and marginal costs for each group, then sets prices allowing sale

19. © 2010 Pearson Education CanadaChapter 8 - 19 Chapter 8 Refresh Slides

20. © 2010 Pearson Education CanadaChapter 8 - 20 MARGINAL REVENUE 1.What is marginal revenue? 2.The connection between marginal revenue and price depends on a business’s competitive environment. Why are marginal revenue and price the same for a business that is a price taker in extreme competition? Why is marginal revenue less than price for a business that is a price maker? continued…

21. © 2010 Pearson Education CanadaChapter 8 - 21 3.Most businesses have to lower the price on all units sold to sell more. But transit systems and movie theatres violate the one-price rule to sell more tickets, lowering prices for students and children while keeping higher prices for adults. How do these businesses get away with this discriminatory policy?

22. © 2010 Pearson Education CanadaChapter 8 - 22 MARGINAL COST 1.What is marginal cost? 2.What if, when the busload of piercing-seeking tourists arrives at Paola’s shop, she has employees on standby she could bring in within 15 minutes, and who would be paid their regular hourly wage? What difference, if any, would that make to Paola’s marginal cost of increasing piercing output? continued…

23. © 2010 Pearson Education CanadaChapter 8 - 23 3.Pick a business and figure out whether marginal costs are increasing or constant. What factors are important to consider?

24. © 2010 Pearson Education CanadaChapter 8 - 24 MARGINAL REVENUE > MARGINAL COST 1.What are the steps in the recipe for maximum total profits, in the order that businesses actually do them? 2.Suppose Paola’s marginal revenues and fixed costs are the same as in Figure 8.3, but her marginal costs are increasing: $1 for the first piercing, $2 for the second, $3 for the third, $4 for the fourth, $5 for the fifth, and $6 for the sixth piercing. What quantity and price will Paola choose if she is making a smart decision? Does the recipe still work? [Hint: Create a table like Figure 8.3.] continued…

25. © 2010 Pearson Education CanadaChapter 8 - 25 3.You have been working too many hours at your part-time job (which pays $10 per hour), and your Economics marks are suffering. Your father, who wants you to do better in school but recognizes your desire for cash, offers you this deal. For every 1% increase in your mark on the next test, he will pay you $6. You estimate that one additional hour of studying will raise your mark 5%; a second hour of studying will raise your mark 4%; a third hour, 3%; a fourth hour, 2%; and a fifth hour, 1%. If all you are trying to do is make the most money, how many hours do you study?

26. © 2010 Pearson Education CanadaChapter 8 - 26 PRICE DISCRIMINATION FOR HIGHER PROFITS 1.In your own words, write the basic recipe for successful price discrimination. 2.Compare the cell phone plan you have chosen with more expensive plans. What factors went into your decision to select your plan? 3.Devise a successful price discrimination plan for Paola’s Piercing and Fingernail Parlour. What “groups” have different elasticities of demand, and what conditions lead them to voluntarily reveal their higher willingness and ability to pay?