1. Managerial Economics Eighth Edition Truett + Truett
Chapter 11: Topics in Pricing and Profit Analysis
John Wiley & Sons, Inc.
12/2/2018
Slides by Jim Witsmeer

2. Discussion Topics Markup Pricing Multiple Products
Price Discrimination
Access Fees
Bundling
Alternatives to Profit Maximization
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3. Merchandise Markup What does it mean? Where is it used? Why?
Markup on price or cost?
Should it be a constant?
How does markup relate to profit maximization?
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4. Profit Maximization & Markup
Profit is maximum when:
From our earlier studies of price elasticity (ch 2) we know.
If AVC is a constant and equals MC, then
profit maximizing markup is inversely related to price elasticity as follows:
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5. Multiple Product Firms
Joint Products
Products that are interdependent in that producing one necessarily results in the production of the other (byproduct).
Transfer Products
Products that one portion of the company produces that are inputs for another product’s production.
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6. Fixed Ratio of Products
Product A and B are joint products with demand and MR curves as shown.
Adding only the positive portion of the marginal revenues we get the bent curve, MRJ + MRA.
If the marginal cost is SMC, then Qe of each product should be produced.
If the marginal cost is reduced to SMC’, then Qe’ of both A and B are produced but (Qe’-Q*) of B will not be sold.
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7. Variable Ratio of Products
The curved lines represent amounts of A & B produced for the same total cost.
The straight lines are isorevenue lines given fixed prices for A & B.
Point D is the maximum profit point in the upper graph.
The three curves in the lower graph reflect three possible levels of production (shifts).
Point E is the maximum profit point in the lower graph.
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8. Transfer Products
Transfer products exist when a firm produces a product that it also uses in another of its products.
Prices are set either by a perfectly competitive market, if applicable, otherwise by the firm in which case the external price will differ.
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9. Transfer Product Pricing
Marginal cost is the total of the transfer and final products.
Marginal revenue includes only the final product.
This fixes the quantity of both products.
The firm can then fix the price of the transfer product at its marginal cost for that quantity.
This ensures that the supplying division is operating at it’s maximum profit point.
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10. Transfer Product Pricing
Under perfectly competitive market for transfer product.
The marginal revenue curve of the transfer product is flat in this case.
At the maximum profit point for the transfer product an excess or shortage exists depending upon the marginal cost curve of it’s supplying division.
In this case the firm should sell excess or buy shortage of the transfer product.
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11. Price Discrimination
Price discrimination occurs when the same product is sold for different prices.
First degree price discrimination offers a different price for each additional item purchased.
Second degree price discrimination offers block discounts for additional items purchased.
Third degree price discrimination involves the separation of markets into segments with different demand curves and prices.
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12. Second Degree Price Discrimination
ZERO COST EXAMPLE DX
MRX
For no cost case with single price set at $5 for maximum profit of $15.
With a discount of $2 for all additional purchases beyond 5 units, consumer will purchase 7 units and profit will increase by $6. PM QM QD PD
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13. First Degree Price Discrimination
Each time the consumer purchases an item you lower the price on the next item the exact amount required to match the demand curve.
NO COST EXAMPLE
By doing this you take advantage of the consumer surplus and fill the space under the demand curve to maximize profit. DX
Do you see any problems with this approach?
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14. Third Degree Price Discrimination
TWO REQUIREMENTS
The market segments must be separated
The market segments must have different price elasticities of demand
LEGALITY – In the U.S. under some circumstances price discrimination can be illegal.
The elasticity of demand can be matched to the price by raising the price where the elasticity of demand is lower.
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15. Third Degree Price Discrimination
HOTEL ROOM RATE EXAMPLE FOR CONVENTIONS AND THE GENERAL MARKET
TC = Rg + 30Rc so that MC = $30 for both markets
Profit is maximum at MR =MC for both markets.
Profit without price discrimination
$51,879 per day
Profit with price discrimination
$52,550 per day
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16. Two-Part Pricing
Using this pricing strategy, to raise profits the seller simply divides the price into two or more parts.
Why do you think this would increase profits?
Can you think of some examples where this is done?
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17. Access Fee Pricing
In the single customer situation the seller can charge the buyer an access fee equal to the consumer surplus without losing the sale.
With multiple customers the seller is constrained to the access fee acceptable to the lowest demand buyer.
The access fee must be considerably higher than the cost of collection.
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18. Bundling
Bundling involves offering a single package price for multiple products. This strategy can be advantageous to the buyer as well.
Bundling works well if there are groups of consumers with inversely related preferences.
Total revenue is increased when both groups by a package at a higher price than required to entice them individually to purchase both items separately.
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19. Alternatives to Profit Maximization
Under what conditions might a firm operate with goals other than maximum profit?
Can this strategy benefit the company in the long run?
What does “benefit the company” mean other than profit?
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20. End of Chapter 11
Copyright © 2004 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the United States copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for resale. The publisher assumes no responsibilities for errors, omissions, or damages, caused by the use of the information contained herein.
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