Lecture 7 - Pricing

Question 1

What’s the assumption we make about pricing

Answer 1

Firms charge one (uniform) price only for each product for all consumers

Question 2

What does price discrimination require

Answer 2

Requires The absence of resale

• Some places resale is illegal
• Cost or resale is very high

Question 3

What are the necessary conditions for successful price discrimination

Answer 3

• Absence of resale
• Firm must have some degree of market power (not possible under PC)
• Market for product must be divisible into sub-markets within which there are different demand conditions (or different price elasticities of Demand)

Question 4

What are the 3 types of price discrimination

Answer 4

• First degree
• Second degree
• Third degree

Question 5

What is first degree price discrimination (also known as perfect price discrimination)

Answer 5

The seller sets different prices for each buyer and for each unit purchased by each buyer thus extracting all of the consumer surplus

• Depends on identity of purchaser and number of units purchased

Question 6

What is second degree price discrimination

Answer 6

• Some instances, the seller has some information about the heterogeneity of the buyers’ preferences but cannot observe the characteristics of each buyer in particular
• Price depends on number of units purchased
• Possible to discriminate between different buyers by means of offering a menu of selling contracts including various clauses in addition to price (bulk purchases)

Question 7

What is third degree price discrimination

Answer 7

• The most common form of discrimination
• If buyers’ characteristics are observable then the seller can establish different prices as a function of the buyers’ characteristics
• Price depends on the identity of the purchaser (not the number of units)
• Divide buyers in groups and set a different price for each group - market segmentation (e.g. student discounts)
• The seller should charge a lower price in those market segments with greater price elasticity

Question 8

What’s cost plus pricing

Answer 8

P = AVC + %markup
P = (1+m) AVC

Question 9

What’s peak load pricing

Answer 9

• When a product varies considerably at different times of day or year, firms may alternatively need to adopt a peak-load pricing method (e.g. energy)
• This involves determining the correct capacity given the changing levels of demand for products, and both peak and off-peak prices

Question 10

What’s transfer pricing

Answer 10

• Associated with Internal markets within multi-division firms
• What price to set for intermediate goods traded between divisions
• Price will impact profit levels of both divisions, and pricing of finished product
• Asymmetric information could influence pricing decision dependent on whether seller wishes to maximise division-level profits