Class 9Class 9

Pricing ModelsPricing Models

Cost Plus PricingCost Plus Pricing

Price DiscriminationPrice Discrimination

Peak Load PricingPeak Load Pricing

Transfer PricingTransfer Pricing

Cost Plus PricingCost Plus Pricing

Price = AVC + % Mark upPrice = AVC + % Mark up

Price = (1+m)*AVCPrice = (1+m)*AVC

However:However:– If AVC varies with output, the firm needs to If AVC varies with output, the firm needs to

know its output level before it can determine know its output level before it can determine its priceits price

– Also, it does not imply price stability if costs Also, it does not imply price stability if costs are themselves changing, or if there are are themselves changing, or if there are demand fluctuationsdemand fluctuations

Cost plus pricing is equal to profit Cost plus pricing is equal to profit maximizing pricing if AVC is approximately maximizing pricing if AVC is approximately constant and mark up is set to a valueconstant and mark up is set to a value

The more price inelastic the demand, the The more price inelastic the demand, the larger mark up is required for profit max.larger mark up is required for profit max.

When competition is high, PED is likely to When competition is high, PED is likely to be hgh in which mark up is smallbe hgh in which mark up is small

Mathematical derivation in the text.Mathematical derivation in the text.

Price DiscriminationPrice Discrimination

Discounts for student or senior citizensBuy two, get one freePhone companies charge different rates to businesses

vs. households.Journals charge different rates to individual subscribers

vs. libraries.Cellular phone companies charge differently depending

on the # of minutes you plan to talk.Reward-the-planned discrimination

Usually tickets that are purchased in advance have lower price

Make-them-pay-for-the-label discriminationToyota Corolla and GEO Prizm come off the same production line, but have

different prices. Is this really pricE discrimination - charging differentprices for the same product? Consumers receiving the label gain status and prestige. Is it the physical

characteristics of a good or its label that determines whether it is the same product?

Keep-them-in-their-zones discriminationPrices change between different neighborhoods within the same city.

Sort-by-value-of-time discriminationProducers supply coupons or rebates to consumers willing to spend the extra

time needed to find and clip them.• Sort-by-eagerness discrimination

Hardcover books vs. paperbacks.End-of-season sales.

Types of Price DiscriminationTypes of Price Discrimination

First degree price discrimination: Price per First degree price discrimination: Price per unit of output depends o the identity of the unit of output depends o the identity of the purchaser and the number of units purchaser and the number of units purchasedpurchasedSecond degree price discrimination: Price Second degree price discrimination: Price depends on the number of units depends on the number of units purchasedpurchasedThird degree price discrimination: Price Third degree price discrimination: Price depends on the identity of the purchaser depends on the identity of the purchaser

First Degree Price DiscriminationFirst Degree Price Discrimination

The condition where market demand The condition where market demand function represents a large number of function represents a large number of consumersconsumers

Eachone either buys one unit of good or Eachone either buys one unit of good or abstains from buying alltogetherabstains from buying alltogether

Reservation price: Maximum price the Reservation price: Maximum price the consumer is willing to payconsumer is willing to pay

Figure 10.1  First-degree price discrimination

The outcome is superior on allocative efficiency The outcome is superior on allocative efficiency criteria for the following reasons:criteria for the following reasons:– in the non discriminating case, it is possible to make in the non discriminating case, it is possible to make

someone better off without making anyone worse off someone better off without making anyone worse off because there is a consumer who is willing to pay a because there is a consumer who is willing to pay a price for extra unit that would exceed the cost of price for extra unit that would exceed the cost of producing this extra unitproducing this extra unit

– With first degree price disc. İt is not possible to make With first degree price disc. İt is not possible to make someone better off withput making anyone worse offsomeone better off withput making anyone worse off

Second Degree Price Disc.Second Degree Price Disc.

It may not be practical to distinguish It may not be practical to distinguish between individuals.between individuals.

Therefore distinguish by groups and Therefore distinguish by groups and charge depending on the units sold.charge depending on the units sold.

Figure 10.2  Second-degree price discrimination (two-part tariff)

Third Degree Price DiscriminationThird Degree Price Discrimination

The monopolist charges different groups The monopolist charges different groups of customers different prices. Price does of customers different prices. Price does not depend on units sold.not depend on units sold.

Figure 10.3  Third-degree price discrimination

Peak Load PricingPeak Load Pricing

Demand variesDemand varies

Peak times and off peak periodsPeak times and off peak periods

Figure 10.5  Peak-load pricing: full capacity production in both periods