Mod 4 - Topic 3 - Pricing Policies

Question 1

What is a cartel?

Answer 1

An arrangement where firms in an industry cooperate and act together as if they were a monopoly.

Question 2

Does a cartel have to be formal? and are they legal?

Answer 2

No they may be informal or formal, and are illegal in the USA (since 1890) - Sherman Antitrust Act. Most famous cartel in existence today is the Organisation of petroleum Exporting Countries (OPEC)

Question 3

What conditions influence the formation of cartels?

Answer 3

• Small number of large firms in the industry
• Geographical proximity of the firms
• Homogenous products that do not allow differentiation
• Stage of the business cycle
• Difficult entry into the industry
• Uniform cost conditions, usually defined by product homogeneity

Question 4

How should a cartel behave and what are the two functions

Answer 4

On a whole as a monopolist. It should determine the output which equates to MR = MC for the whole cartel and then set price according to this point.

Question 5

What is the key problem with a cartel (other than its legality)?

Answer 5

There is incentive for firms to cheat on agreement, thus cartels are unstable.

Question 6

What costs does a cartel face?

Answer 6

• Formation costs
• Monitoring costs
• Enforcement costs
• Cost of punishment by authorities

Question 7

What are two examples of price fixing by cartels?

Answer 7

• GE, Westinghouse

* Sotherbys, Christies

Question 8

What is price leadership?

Answer 8

One company in an oligopolistic industry establishes the price and the other companies follow

Question 9

What are two types of price leadership that are common?

Answer 9

• Barometric price leadership

* Dominant price leadership

Question 10

What is barometric price leadership?

Answer 10

In an oligopolistic industry, it is a situation where one firm, perceiving that demand and supply conditions warrant it, announces a price change, expecting that others will follow. If they do not, the leader may rescind the price increase

Question 11

What is dominant price leadership?

Answer 11

In an oligopolistic industry a firm usually the largest, sets a price at which it will maximise its profits allowing other firms to sell as much as they want at that price.

Question 12

What are the impacts of dominant price leadership on other firms?

Answer 12

• It can force them out of business
• Force them to sell out under terms favourable to the buyer
• could result in investigation under Sherman Antitrust Act

Question 13

In setting price what must a dominant price leader consider?

Answer 13

The amount supplied by all firms. The dominant firm equates its marginal cost with marginal revenue from its residual demand curve.

Question 14

What is price discrimination?

Answer 14

It is a situation in which an identical product is sold in different markets at different prices or that the ratio of price to marginal cost differs for similar products.

Question 15

What are the two conditions present for price discrimination to occur?

Answer 15

• the markets in which the products are sold must be separated (so no resale between markets)
• the demand curves in the market must have different elasticities.

Question 16

Economists normally identify three degrees of price discrimination. What is the first degree of price discrimination?

Answer 16

• Seller can identify where each consumer lies on the demand curve and charges each consumer the highest price they are willing to pay - allows them to extract greatest profit, but does require a lot of information.

Question 17

Economists normally identify three degrees of price discrimination. What is the second degree of price discrimination?

Answer 17

Differential prices are charged by blocks of services. Ie, a high price is charged for small use and lower price for high use. This requires a metering of services consumed by buyers.

Question 18

Economists normally identify three degrees of price discrimination. What is the third degree of price discrimination?

Answer 18

Consumers are segregated into different markets and charged different prices in each. Segmentation can be based on any characteristic such as age, location, gender or income.

Question 19

What are four examples of price discrimination?

Answer 19

• Doctors - fees set in accordance with income
• Pubs & clubs - ladies hour
• Theatres - cheaper tickets for adults seeing kids movies
• Sports events - cheaper tickets for children / seniors
• Utilities - charge more to business than residential
• University - higher cost to overseas students

Question 20

What is a tying arrangement?

Answer 20

A possible extension of price discrimination where a buyer of one product is obligated to also buy a related product from the same supplier.

Question 21

Are tying arrangements illegal and what are three reasons why they are used?

Answer 21

In some cases they are illegal. The reasons they are used:

• Quality control - arrangement ensures quality
• Distribution efficiency - lower cost if distributed together
• Evasion of price controls

Question 22

What is cost-plus pricing?

Answer 22

Price is set by first calculating the variable cost, adding an allocation for fixed costs and then adding a profit percentage or mark up.

Question 23

What is the problem with cost-plus pricing (3)?

Answer 23

• how is average variable cost calculated?
• how to allocate fixed cost?
• how to determine the size of the mark up

Question 24

What is incremental pricing (and costing) analysis?

Answer 24

Deals with changes in total revenue and total cost resulting from a decision to change prices or product. This is similar to marginal pricing and only considers revenue and costs that will change due to the decision.

Question 25

What is multiproduct pricing?

Answer 25

It is when the firm produces two or more products - Products may compete for resources and pricing may consider whether the other product is a substitute or complement.

Question 26

What is transfer pricing?

Answer 26

It is a form of internal pricing, as the product moves through each division of the firm it is ‘sold’ or ‘transferred’ to another unit at a transfer price.

Question 27

What is the rationale behind transfer pricing (2)?

Answer 27

• The firm is subdivided and each may have a profit objective
• Without coordination the final price may not maximise whole of company profits.

Question 28

How is the design of the optimal transfer pricing mechanism complicated?

Answer 28

• each division may be able to sell eternally as well as internally
• each division may be able to procure inputs externally as well as internally.

Question 29

What is price skimming?

Answer 29

The first firm to introduce a product may have a temporary monopoly and may be able to charge higher prices to obtain high profits until competition enters.

Question 30

What is penetration pricing?

Answer 30

Selling at a low price in order to obtain market share.

Question 31

What is prestige pricing?

Answer 31

Demand for a product may be higher at a higher price due to the prestige that ownership bestows on that consumer.

Question 32

What is psychological pricing?

Answer 32

Demand for a product may be quite inelastic over a certain range but will become rather elastic at one specific higher or lower price.