Chapter 10

Question 1

What is a pricing strategy?

Answer 1

This is a firm’s plan for setting prices of its products given the market conditions it fases and its desire to maximize profits.

Question 2

What is price discrimination?

Answer 2

This is the practice of charging different prices to different customers for the same product.

Question 3

What are the conditions for price discriminations?

Answer 3

1. Firms must have market power required to price discriminate
2. Firms must prevent resale and arbitrage

Question 4

What is arbitrage?

Answer 4

Buying a product against the original selling price and reselling it for a higher price.

Question 5

What does the type of pricing strategy depend on?

Answer 5

1. The firm’s ability to identify its customers’ demand before they buy
2. If a firm can only identify customer demands after purchase, can it try to bundle products together?

Question 6

What is price discrimination?

Answer 6

This is a pricing strategy in which firms charge different prices to different types of customers based on observable characteristics of the customers.

Question 7

When should you use perfect price discrimination?

Answer 7

1. Type of direct price discrimination in which a firm charges each customer exactly his WTP. The producer surplus will be the triangle below demand curve and above MC. No consumer surplus. There is no deadweight loss.

Question 8

When should firms use a segmenting price strategy (Third-degree)

Answer 8

1. Firm has market power to and can prevent resale
2. Firm’s customers have different demand curves
3. Firms can identify groups of customers with different price sensitivities but not individual demand of each customer before purchase.

Question 9

What is segmenting?

Answer 9

This is a price-discrimination strategy in which a firm charges different groups of custoemrs different prices based on the identifiable attributes of those groups. Idea is that each segment can be treated as seperate market where we can apply Lerner index to find the optimal point to the markup price over marginal cost.

Question 10

Name four ways to directly segment customers

Answer 10

1. By customer characteristics (identify price-sensitivity of customer groups)
2. By past purchase behavior: Pay attention to high switching costs
3. By location: in some areas, people are less price sensitive (airport-town)
4. Over time: Enthusiastic customers want newest version of product (less price-elastic)

Question 11

When should firms use second-degree price discrimination?

Answer 11

1. Firm has market power to and can prevent resale
2. Firm’s customers have different demand curves
3. Firms cannot directly identify with customers have which type of demand before purchase.

Question 12

What is second-degree price discrimination (indirect)?

Answer 12

This is a pricing strategy where customers pick among a variety of pricing choices provided by the firm. The underlying idea is that customers sort themselves into the ‘right’ choice.

Question 13

How can quantity discounts be used in price discrimination?

Answer 13

Quantity discounts is a pricing strategy where customers who buy larger quantities of a good pay lower per-unit price. This is one of the most basic indirect pricing strategies. Its most effective when customers who buy in large quantities are more elastic than those buying smaller amounts. This is often done by setting requirements to attain cheaper options.

Question 14

What is the essence of a successful indirect price-discrimination strategy?

Answer 14

The firm must set prices so that a customer doesn’t try to fake her demand type by buying the package meant for another customer type. Therefore, consumer surplus for low-usage customers needs to be higher at higher prices.

Question 15

What is incentive compatibility?

Answer 15

Requirement under indirect price discrimination strategies that the price offered to each customer group is chosen by that group.

Question 16

What is versioning?

Answer 16

This is a pricing strategy in which the firm offers different product options designed to attract different types of consumers. Prices of each version must be incentive-compatible.

The markup of price over marginal cost has to bigger for the versions bought by customers with less elastic demand.

Question 17

When should a firm use bundling?

Answer 17

1. Firm has market power and can prevent resale
2. Firm sells a second product and consumers’ demand is negatively correlated with their demand for the first product.

Question 18

What is bundling?

Answer 18

This is a pricing strategy in which the firm sells two or more products together at a single price.

Question 19

How can bundling increase consumer surplus?

Answer 19

Bundling can increase consumer surplus when WTP for the two goods is negatively correlated across the consumers. Then the firm creates more producer surplus by selling bundles as opposed to selling seperately.

Question 20

What is mixed bundling?

Answer 20

This is a type of bundling in which the firm offers consumers the choice of buying two or more products seperately of as a bundle simultaneously. This is better than pure bundling when MC of producing some of the components is high enough relative to some consumers’ WTP.

Question 21

What is pure bundling?

Answer 21

A firm offers products only in a bundle