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MANAGERIALMANAGERIAL

ECONOMICS 11ECONOMICS 11thth EditionEdition

ByBy

Mark HirscheyMark Hirschey

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Pricing PracticesPricing PracticesChapter 15Chapter 15

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Chapter15Chapter15

OVERVIEWOVERVIEW

Pricing Rules-of-thumb

Markup Pricing And Profit Maximization

Price Discrimination

Price Discrimination Example

Multiple-productPricing

JointProducts

JointProductPricing Example

Transfer Pricing

Global Transfer Pricing Example

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Chapter15Chapter15

KEY CONCEPTSKEY 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 price discrimination

market segment first-degree price

discrimination second-degree price

discrimination third-degree price

discrimination by-product common costs vertical relation vertical integration transfer pricing

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Pricing Rules-of-thumb

Competitive Markets Profit maximization always requires setting M= MR - MC= 0, or MR=MC, to maximize profits.

In competitive markets, P=MR, so profit maximizationrequires setting P=MR= MC.

Imperfectly Competitive Markets With imperfect competition, P > MR, so profit

maximization requires setting MR=MC. MR =P[1 + (1/P)]

Optimal P*= MC/[1 + (1/P)]

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Markup Pricing And Profit

Maximization Optimal Markup on Cost

Markup on cost uses cost as a basis.

Markup pricing is an efficient means forachieving the profit maximization objective.

Optimal markup on cost= -1/(P + 1)

Optimal Markup on Price

Markup on price uses price as a basis.

Optimal markup on price = -1/P

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Price Discrimination

Profit-Making Criteria Price discrimination exists ifP1/P2 MC1/MC2.

Ability to segment the market.

Multiple markets with no reselling. Price elasticity of demand differs across submarkets.

Degrees ofPrice Discrimination First degree: Different prices for each consumer.

Creates maximum profits for sellers. Second degree: Block-rates or quantity discounts.

Third degree: Different prices by customer age, sex,income, etc. (most common).

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Price Discrimination Example

Price/Output Determination Maximizes profits by setting MR=MC in each market

segment.

One-price Alternative Without price discrimination, MR=MC for customers

as a group.

With price discrimination, MR=MC for each customeror customer segment.

Profitable price discrimination benefits sellers at theexpense of some customers.

Graphic Illustration

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Multiple-productPricing

Demand Interrelations

Cross-marginal revenue terms indicate howproduct revenues are related to another.

Production Interrelations

Joint products may compete for resources orbe complementary.

A by-product is any output customarilyproduced as a direct result of an increase inthe production of some other output.

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Joint Products

JointProducts in Variable Proportions

If products are produced in variableproportions, treat as distinct products.

For joint products produced in variableproportions, set MRA=MCA and MRB=MCB.

Common costs are joint product expenses.

Allocation of common costs is wrong and arbitrary.

JointProducts in Fixed Proportions

Some products are produced in a fixed ratio.

If Q=QA=QB, set MRQ=MRA+MRB=MCQ.

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Joint Product Pricing Example

JointProducts Without Excess By-product

Profit-maximization requires settingMR

Q

=MRA

+MRB

=MCQ

.

Marginal revenue from each byproduct makesa contribution toward covering MCQ.

JointProduction With Excess By-product

(Dumping) Profit-maximization requires setting

MRQ=MRA+MRB=MCQ.

Primary product marginal revenue covers MCQ.

B roduct MR=MC=0.

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TransferPricing

Transfer Pricing Problem Pricing transfer of products among divisions of a

single firm can become complicated.

Products Without External Markets Marginal cost is the appropriate transfer price.

Products With Competitive External Markets Market price is the optimal transfer price.

Products With Imperfectly Competitive External

Markets Optimal transfer price is the marginal revenue derived

from combined internal and external markets.

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Global TransferPricing Example

Profit Maximization for an Integrated Firm Optimal transfer price is profit maximizing.

Transfer Pricing with No External Market Optimal transfer price balances supply/demand.

Competitive External Market with ExcessInternal Demand Firm employs own and external inputs.

Competitive External Market with ExcessInternal Supply Firm supplies inputs to internal and external markets.