Part III: Analysis of firm strategy Pricing SLIDESHOW 9 Flashcards
What is the form of cost plus pricing principle?
Price is determined by adding a percentage mark-up to average variable cost
Why is cost plus pricing may produce greater price stability?
Because it shouldn’t change every time there is a minor variation in demand
How is valued price stability?
By consumers : reduces their search costs.
By producers : reduces likelihood that destructive price competition may break out.
What are the 3 advantages of cost plus pricing?
1\ EZ to understand, need less information to be implemented
2\ Greater price stability
3\ Sense of fairness
What does the firm need to do in order to put in place a cost plus pricing?
Average Variable Cost, thus estimate demand function
When is cost plus pricing equivalent to profit-maximizing pricing?
If AVC is approximately constant, and the mark-up is set to a value of 1/(PED-1)
What if the firm’s demand is price inelastic?
The larger the mark-up is required for profit-maximization
What happens in difficult economic periods?
PED is high an the mark-up is small. Same when competition is intense
What happens in great economic periods?
Mark-up is larger. Same when competition is weak
What are the various objectives that might be considered when formulating prices?
1\ Target profitability 2\ Target sales revenue 3\ Target market share, price stability 4\ Stability of sales volume 5\ Comparability of own prices with those of competitors 6\ Prices perceived as fair by customers
When does price discrimination happen?
When there are variations in the prices charged for a product that is supplied under an identical cost structure no matter the buyers or # units produced and sold
Due to difference in costs, prices might be different, is it price discrimination?
No. Contrary yes !
What are the 3 types of price discrimination?
1\ 1st degree = perfect price discrimination. Indentity of purchase and # of units purchased matters.
2\ 2nd. Depends on # units purchased.
3\ 3rd. Depends on identity of purchaser.
What is dumping?
Charging a lower price to consumers in poorer countries than those in richer ones.
What are the 2 conditions for a policy of price discrimination to be possible?
1\ Price discriminating firm must enjoy some degree of market power
2\ Market for the product must be divisible into sub-markets with different demand conditions (or different price elasticities also)
What is the reservation price?
The maximum price the consumer is willing to pay
Give a first polar case of 1st degree price discrimination.
The market demand function represents a large number of consumers
Give a second polar case of 1st degree price discrimination
One consumer, whose willingness to pay decreases as the number of units purchased increases
What is worthwhile for the monopolist?
To supply all consumers whose reservation prices exceed the monopolist’s marginal cost. –> Surplus
How could a monopolist also obtain a surplus?
By charging a two-part tariff (fixed fee + additional uniform price for each unit purchased)
Why is the outcome superior on allocative efficiency criteria for 1st degree price discrimination?
In non-discriminating case, possible to make someone better off without making anyone else worse off. In 1st degree price discrimination, not possible.
What is better if the monopolist can distinguish between consumers?
Offer the same menu of prices and quantities to all consumers
What is the 3rd price discrimination?
Offering different prices to different consumers
With what must the nature of the individual’s demand function be correlated?
The identifying characteristic
What does the monopolist do in a third degree price discrimination?
1\ segments market into groups
2\ charges same price/unit sold within each group
3\ charges different prices to members of different groups
What are the 2 unequivocal conclusions that can be drawn of the 3rd degree discrimination?
1\ monopolist’s abnormal profit is always higher than in non-discriminating case
2\ When 2 sub-markets, one price will always be higher and the other lower than the uniform monopoly price in the non-discriminating case
What is intertemporal price discrimination?
When products are more expensive now than later
How could the practise of intertemporal price discrimination be limited?
By the strategic behaviour on the part of consumers
Give other examples of price discrimination
1\ Brand labels
2\ Loyalty discounts
3\ Coupons
4\ Stock clearance ; Dutch auction also
What is a peak load pricing?
When demand varies at different times of the period
From where does transfer pricing come?
When a division of a firm uses the output of another division as one of its inputs
In which firm’s form does transfer pricing usually take place?
M-form and H-form
What is the goal of transfer pricing?
Determining the prices of intermediate products
Why is transfer pricing a crucial decision?
Because it affects the imputed revenues of the selling division, the imputed costs of the buying division and therefore the imputed profitability of both divisions and of the firm as a whole
What are the 3 cases in transfer pricing?
1\ all production output passed to distribution
2\ Competitive external market, production surplus intermediate output can be sold or distribution division can obtain additional supplies through external market
3\
In the second case, how should the transfer pricing be?
Perfectly competitive price in order to buy and sell in the firm
Why is transfer pricing a controversial topic in the case of multinational firms?
There are strong incentives for firms to set their transfer prices in such a way as to shift profits towards divisions located in countries with low rates of corporation tax (tax on company profits) –> vertically integrated multinationals
