chapter tencopyright 2009 pearson education, inc. publishing as prentice hall. 1 chapter 10 special...
TRANSCRIPT
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
1
Chapter 10
Special Pricing Policies
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
2
Overview
Cartel arrangementsPrice leadershipRevenue maximizationPrice discriminationNonmarginal pricingMultiproduct pricingTransfer pricing
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
3
Cartel arrangements A cartel is an arrangement where firms in
an industry cooperate and act together as if they were a monopoly
• cartel arrangements may be tacit or formal
• illegal in the US: Sherman Antitrust Act, 1890
• examples: OPEC
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
4
Cartel arrangements Conditions that influence the formation of
cartels small number of large firms in the
industry geographical proximity of the firms homogeneous products that do not
allow differentiation stage of the business cycle difficult entry into industry uniform cost conditions, usually defined
by product homogeneity
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
5
Cartel arrangements In order to maximize profits, the cartel as
a whole should behave as a ‘monopolist’ the cartel determines the output which
equates MR = MC of the cartel as a whole the MC of the cartel as a whole is the
horizontal summation of the members’ marginal cost curves
price is set in the normal monopoly way, by determining quantity demanded where MC=MR and deriving P from the demand curve at that Q
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
6
Cartel arrangements
MCT is the horizontal sum of MCI and MCII
QT is found at the intersection of MRT and MCT
price is found from the demand curve at QT … this is the price that maximizes total industry profits
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
7
Cartel arrangements
to determine how much each firm should produce, draw a horizontal line back from the MRT/MCT intersection
where this line intersects each individual firm’s MC determines that firm’s output, QI and QII. Note that the firms may produce different outputs
Key point: the MC of the last unit produced is equated across both firms
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
8
Cartel arrangements
Profits for each firm are shown as rectangles in blue
Firms may earn different levels of profit, though combined profits are maximized
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
9
Cartel arrangements Problem: incentive for firms to cheat on
agreement, thus cartels are unstable
Additional costs facing the cartel formation costs monitoring costs enforcement costs cost of punishment by authorities
weigh the benefits against these costs
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
10
Cartel arrangements Examples: price fixing by cartels
GE, Westinghouse Archer Daniels Midland Company Sotheby’s, Christie’s Roche Holding AG, BASF AG
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
11
Price leadership Barometric price leadership
one firm in an industry will initiate a price change in response to economic conditions
the other firms may or may not follow this leader
leader may vary
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
12
Price leadership Dominant price leadership
one firm is the industry leader dominant firm sets price with the
realization that the smaller firms will follow and charge the same price
can force competitors out of business or buy them out under favorable terms
could result in investigation under Sherman Anti-Trust Act
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
13
Price leadership DT = demand curve
for entire industry
MCD = marginal cost of the dominant firm
MCR = summation of MC of follower firms
in setting price, dominant firm must consider the amount supplied by all firms
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
14
Price leadership
Demand curve facing the dominant firm is found by subtracting MCR from DT
dominant firm equates its MC with MR from its ‘residual demand curve’ DD
the dominant firm sells A units and the rest of the demand (QT – A) is supplied by the follower firms
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
15
Revenue maximization Baumol model: firms maximize revenue
(not profit) subject to maintaining a specific level of profits
Rationalea firm will become more competitive
when it achieves a large sizemanagement remuneration may be
related to revenue not profits Implication: unlike the profit maximization
case, a change in fixed costs will alter price and output (by raising the cost curve and lowering the profit line)
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
16
Price discrimination Price discrimination: products with
identical costs are sold in different markets at different prices
the ratio of price to marginal cost differs for similar products
Conditions for price discrimination the markets in which the products are
sold must by separated (no resale between markets)
the demand curves in the market must have different elasticities
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
17
Price discrimination First degree price discrimination
seller can identify where each consumer lies on the demand curve and charges each consumer the highest price the consumer is willing to pay
allows the seller to extract the greatest amount of profits
requires a considerable amount of information
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
18
Price discrimination Second degree price discrimination
differential prices charged by blocks of services
requires metering of services consumed by buyers
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
19
Price discrimination Third degree price discrimination
customers are segregated into different markets and charged different prices in each
segmentation can be based on any characteristic such as age, location, gender, income, etc
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
20
Price discrimination
Third degree discrimination:• assume the firm operates in two markets, A and B• the demand in market A is less elastic than the demand in market B• the entire market faced by the firm is described by the horizontal
sum of the demand and marginal revenue curves …
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
21
Price discrimination
• the firm finds the total amount to produce by equating the marginal revenue and marginal cost in the market as a whole: QT
• if the firm were forced to charge a uniform price, it would find the price by examining the aggregate demand DT at the output level QT
• the firm can increase its profits by charging a different price in each market …
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
22
Price discrimination
• in order to find the optimum price to charge in each market, draw a horizontal line back from the MRT/MCT intersection
• where this line intersects each submarket’s MR curve determines the amount that should be sold in each market: QA and QB
• these quantities are then used to determine the price in each market using the demand curves DA and DB
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
23
Price discrimination
Examples of price discrimination
• doctors
• telephone calls
• theaters
• hotel industry
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
24
Price discrimination Tying arrangement: a buyer of one
product is obligated to also buy a related product from the same supplier
illegal in some cases one explanation: a device to ‘meter’
demand for tied product other explanations of tying
quality controlefficiencies in distributionevasion of price controls
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
25
Nonmarginal pricing Cost-plus pricing: price is set by first
calculating the variable cost, adding an allocation for fixed costs, and then adding a profit percentage or markup
Problems with cost-plus pricing
calculation of average variable costallocation of fixed costsize of the markup
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
26
Nonmarginal pricing Incremental pricing (and costing)
analysis: deals with changes in total revenue and total cost resulting from a decision to change prices or product
Features:• incremental, similar to marginal analysis• only revenues and costs that will change
due to the decision are considered• examples of product change: new
product, discontinue old product, improve a product, capital equipment
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
27
Multiproduct pricing When the firm produces two or more
products
Case 1: products are complements in terms of demand an increase in the quantity sold of one will bring about an increase in the quantity sold of the other
Case 2: products are substitutes in terms of demand an increase in the quantity sold of one will bring about a decrease in the quantity sold of the other
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
28
Multiproduct pricing When the firm produces two or more
products
Case 3: products are joined in production products produced from one set of inputs
Case 4: products compete for resources using resources to produce one product takes those resources away from producing other products
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
29
Transfer pricing Internal pricing: as the product moves
through these divisions on the way to the consumer it is ‘sold’ or transferred from one division to another at a ‘transfer price’
Rationale:• firm subdivided into divisions, each may
be charged with a profit objective• without any coordination, the final price of
the product to consumers may not maximize profits for the firm as a whole
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
30
Transfer pricing Design of the optimal transfer pricing
mechanism is complicated by the fact that
each division may be able to sell its product in external markets as well as internally
each division may be able to procure inputs from external markets as well as internally
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
31
Transfer pricing Case A: no external markets
no division can buy from or sell to an external market
the selling division will produce exactly the number of components that will be used by the purchasing division
one demand curve and two MC curves MC curves are summed vertically set production where MR = Total MC
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
32
Transfer pricing Case B: external markets
divisions have the opportunity to buy or sell in outside competitive markets
if selling division prices above the external market price, the buying division will buy from outside
if selling division cannot produce enough to satisfy buying division demand, the buying division will buy additional units from the external market
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
33
Other pricing practices Price skimming
the first firm to introduce a product may have a temporary monopoly and may be able to charge high prices and obtain high profits until competition enters
Penetration pricing selling at a low price in order to obtain
market share
Chapter Ten Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall.
34
Other pricing practices Prestige pricing
demand for a product may be higher at a higher price because of the prestige that ownership bestows on the owner
Psychological pricing demand for a product may be quite inelastic
over a certain range but will become rather elastic at one specific higher or lower price