Chapter 14

Copyright © 2008 by the McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill/IrwinManagerial Economics, 9e

Managerial Economics ThomasMauriceninth edition

Copyright © 2008 by the McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill/IrwinManagerial Economics, 9e

Managerial Economics ThomasMauriceninth edition

Chapter 14

Advanced Pricing Techniques

Managerial EconomicsManagerial Economics

14-2

Advanced Pricing Techniques

• Price discrimination• Multiple products• Cost-plus pricing


14-3

Capturing Consumer Surplus

• Uniform pricing• Charging the same price for every unit of

the product• Price discrimination

• More profitable alternative to uniform pricing

• Market conditions must allow this practice to be profitably executed

• Technique of charging different prices for the same product

• Used to capture consumer surplus (turning consumer surplus into profit)


14-4

The Trouble with Uniform Pricing (Figure 14.1)


14-5

Price Discrimination

• Exists when the price-to-marginal cost ratio differs between two products:

A B

A B

P P

MC MC


14-6

Price Discrimination

Three conditions necessary to practice price discrimination profitably:

1) Firm must possess some degree of market power

2) A cost-effective means of preventing resale between lower- and higher-price buyers (consumer arbitrage) must be implemented

3) Price elasticities must differ between individual buyers or groups of buyers


14-7

First-Degree (Perfect) Price Discrimination• Every unit is sold for the maximum

price each consumer is willing to pay• Allows the firm to capture entire

consumer surplus

• Difficulties• Requires precise knowledge about every

buyer’s demand for the good• Seller must negotiate a different price for

every unit sold to every buyer


14-8

First-Degree (Perfect) Price Discrimination (Figure 14.2)


14-9

Second-Degree Price Discrimination

• Lower prices are offered for larger quantities and buyers can self-select the price by choosing how much to buy

• When the same consumer buys more than one unit of a good or service at a time, the marginal value placed on additional units declines as more units are consumed


14-10


• Two-part pricing• Charges buyers a fixed access charge (A) to

purchase as many units as they wish for a constant fee (f) per unit

• Total expenditure (TE) for q units is:

TE A fq

Af

q

TE A fqp

q q

Average price ( ) is:p


14-11


• When consumers have identical demands, entire consumer surplus can be captured by:• Setting f = MC• Setting A = consumer surplus (CS)

• Optimal usage fee when two groups of buyers have identical demands is the level for which MRf = MCf


14-12

Inverse Demand Curve for Each of 100 Identical Senior Golfers (Figure 14.3)


14-13

Demand at Northvale Golf Club (Figure 14.4)


14-14


• Declining block pricing• Offers quantity discounts over

successive discrete blocks of quantities purchased


14-15

Block Pricing with Five Blocks (Figure 14.5)


14-16

Third-Degree Price Discrimination

• If a firm sells in two markets, 1 & 2• Allocate output (sales) so MR1 = MR2

• Optimal total output is that for which MRT = MC

• For profit-maximization, allocate sales of total output so that MRT = MC = MR1 = MR2


14-17

Third-Degree Price Discrimination

• Equal-marginal-revenue principle• Allocating output (sales) so MR1 =

MR2 which will maximize total revenue for the firm (TR1 + TR2)

• More elastic market gets lower price

• Less elastic market gets higher price


14-18

Allocating Sales Between Markets (Figure 14.6)


14-19

Constructing the Marginal Revenue Curve (Figure 14.7)


14-20

Profit-Maximization Under Third-Degree Price Discrimination (Figure 14.8)


14-21

Multiple Products

• Related in consumption• For two products, X & Y, produce &

sell levels of output for which

MRX = MCX and MRY = MCY

• MRX is a function not only of QX but

also of QY (as is MRY) -- conditions must be satisfied simultaneously


14-22

Multiple Products

• Related in production as substitutes• For two products, X & Y, allocate

production facility so that

MRPX = MRPY

• Optimal level of facility usage in the long run is where MRPT = MC

• For profit-maximization:

MRPT = MC = MRPX = MRPY


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Multiple Products

• Related in production as complements• To maximize profit, set joint marginal

revenue equal to marginal cost:

MRJ = MC• If profit-maximizing level of joint

production exceeds output where MRJ kinks, units beyond zero MR are disposed of rather than sold

• Profit-maximizing prices are found using demand functions for the two goods


14-24

Profit-Maximizing Allocation of Production Facilities (Figure 14.9)


14-25

Profit-Maximization with Joint Products (Figure 14.11)


14-26

Cost-Plus Pricing

• Common technique for pricing when firms do not wish to estimate demand & cost conditions to apply the MR = MC rule for profit-maximization

• Price charged represents a markup (margin) over average cost:

P = (1 + m)ATC Where m is the markup on unit cost


14-27

Cost-Plus Pricing

• Does not generally produce profit-maximizing price• Fails to incorporate information on

demand & marginal revenue• Uses average, not marginal, cost


14-28

Practical Problems with Cost-Plus Pricing (Figure 14.13)

Chapter 14

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