1. MANAGERIAL ECONOMICS 12th EditionBy
Mark Hirschey

2. Pricing Practices
Chapter 15

3. Chapter 15 OVERVIEW Pricing Rules-of-thumb
Markup Pricing And Profit Maximization
Price Discrimination
Price Discrimination Example
Two-part Pricing
Multiple-product Pricing
Joint Products
Joint Product Pricing Example

4. Chapter 15 KEY CONCEPTS competitive market pricing rule-of-thumb
imperfectly competitive pricing rule-of-thumb
markup on cost
profit margin
optimal markup on cost
markup on price
optimal markup on price
Lerner Index of Monopoly Power
peak periods
off peak periods
price discrimination
market segment
first-degree price discrimination
second-degree price discrimination
third-degree price discrimination
two-part pricing
bundle pricing
by-product
common costs
vertical relation
vertical integration
transfer pricing

5. Pricing Rules-of-thumb
Competitive Markets
Profit maximization always requires setting Mπ = MR - MC = 0, or MR=MC, to maximize profits.
In competitive markets, P=MR, so profit maximization requires setting P=MR= MC.
Imperfectly Competitive Markets
With imperfect competition, P > MR, so profit maximization requires setting MR=MC.
MR = P[1 + (1/εP)]
Optimal P* = MC/[1 + (1/εP)]

6. Markup Pricing and Profit Maximization
Optimal Markup on Cost
Markup pricing is an efficient means for achieving profit maximization.
Markup on cost uses cost as a basis.
Optimal markup on cost = -1/(εP + 1).
Optimal Markup on Price
Markup on price uses price as a basis.
Optimal markup on price = -1/εP

7. Price Discrimination Profit-Making Criteria
Price elasticity of demand must differ in submarkets.
Must have ability to prevent reselling.
Price discrimination exists if P1/P2 ≠ MC1/MC2.
Degrees of Price Discrimination
First degree creates different prices for each customer (maximum profits).
Second degree gives quantity discounts.
Third degree assigns different prices by customer age, sex, income, etc. (most common).

9. Price Discrimination Example
Price/Output Determination
To maximize profits, set MR=MC in each market.
One-price Alternative
Without price discrimination, MR=MC for all customers as a group.
With price discrimination, MR=MC for each customer or customer group.
Profitable price discrimination benefits sellers at the expense of some customers.

13. Two-Part Pricing One-price Policy and Consumer Surplus
A single price policy creates bargains for avid buyers; they enjoy consumer surplus.
Consumer surplus reflects unpaid benefit.
Capturing Consumer Surplus With Two-part Pricing
Lump-sum prices plus user fees capture consumer surplus for producers, e.g., club memberships.
Consumer Surplus and Bundle Pricing
When significant consumer surplus exists, profits can be enhanced if products are purchased together.

16. Multiple-product Pricing
Demand Interrelations
Cross‑marginal revenue terms indicate how product revenues are related to another.
Production Interrelations
Joint products may compete for resources or be complementary.
A by-product is any output customarily produced as a direct result of an increase in the production of some other output.

17. Joint Products Joint Products in Variable Proportions
If products are produced in variable proportions, they are distinct outputs.
For joint products produced in variable proportions, set MRA= MCA and MRB= MCB.
Allocation of common costs is wrong and arbitrary.
Joint Products in Fixed Proportions
Some products are produced in a fixed ratio.
If Q = QA= QB, set MRQ= MRA+ MRB = MCQ.

20. Joint Product Pricing Example
Joint Products Without Excess By-product
Profit-maximization requires setting MRQ= MRA+MRB = MCQ.
Marginal revenue from each byproduct makes a contribution toward covering MCQ.
Joint Production With Excess By-product (Dumping)
Profit-maximization requires setting MRQ= MRA+MRB= MCQ.
Primary product marginal revenue covers MCQ.
Byproduct MR=MC=0.