Pricing Decisions Flashcards
Week 9 & 10
How are Pricing decisions made?
- Based on theories of demand, cost and market structure
- Pricing decisions can be aspirational or strategical
What is the definition of a Market?
- Consists of al firms willing to sell to consumers wiling to buy a product at a given price
What is competition?
- How readily available substitutes
- Substitutes have similar performance, occurrence, sales in the market, characteristics
How can market structures be determined? How does this affect the firms?
- Number of firms
- Size of firms
- Distribution of firms
- Freedom of entry
- The extent of product differentiation
- Determines how firms interact with each other and how firms can set prices
What is the monopolist price setting condition?
- MC = MR
- This is the profit maximisation point
What is the perfectly competitive price setting condition?
- P = MC
Name some characteristics of Perfect Competition
- Homogenous goods
- No economic profit in the LR
- Many firms
- 0 barriers to entry
- Perfect Knowledge
Name some characteristics of Monopolies
- One seller
- Supernormal profit
- High barriers to entry
- Few substitutes
- High market power
Name some characteristics of Oligopolies
- A few firms
- Collusion may occur
- High barriers to entry
- Preditory pricing
- Partial market power
Name some characteristics of Monopolistic Competition
- Somewhat heterogenous goods
- Many firms
- Some barriers to entry
- Can set some prices
What markets are pricing strategies most likely to be in?
- Markets where power can be exercised
- Oligopoly/Monopoly
How can advertisement help in competition strategy? What are the two advertisement types?
- Non-Pricing strategy
- Incentive to attract more customers at the expense of others
- 2 types; advertisement to make demand more/less elastic
- MORE: Coupons, weekly ads in papers, end-of-aisle display
- LESS: Quality and experience focus (usually luxury)
What is Price Discrimination? How can it be achieved?
- Price Discrimination: The business of selling the sam e good at different prices to different consumers
- High PED, high Price Discrimination
- Firms must have perfect information on PED
- Firms must have some market power
- Resale market must not be present
What is 1st Degree Price Discrimination?
- Seller knows maximum price that each individual is willing to pay
What is 2nd Degree Price Discrimination?
- Consumers are offered different packages at different prices
What is 3rd Degree Price Discrimination?
- Seller can identify two or more separate markets based on time/location …
What is predatory pricing?
- Large incumbent firms set prices deliberately high to drive out other firms (rivals or entrants)
- This is illegal in many countries and UBER was charged with this
What is limit pricing?
- Incumbent firms charge lower prices to deter others from entering a market
- Entrants see a low price and believe prices will lower when they enter a market- won’t cover sunk costs
- Incumbent believes it is better to be a monopoly at limit price than share at duopoly price
- This is seen in a lower AC curve
What are the factors that determine a limit price?
- Cost differences
- Demand level
- Elasticity
- Extent of economies of scale
- Expected reaction of other firms
When should limit pricing be pursued?
- PV(LP) > PV(profit max)
- Dependant on discount rate and a firm’s objective
- Limit pricing if there is a lot of uncertainty about the entrant, incumbent and imperfect information
What is bundling?
- Combination of goods sold at below market price than if they were sold separately
- Meal deal, Netflix Bundles
- Incumbent firm could be a monopoly in one market, but feel threatened in another market
What is new product pricing? What are the two different strategies?
- The firm must price the product and find a promotional mix that will maximise profits, with the difficulty of estimating demand and costs
- The two strategies are skimming prices and penetrating prices
What are Skimming Prices? Provide a small outline of this
- The firm intially set a high price to satisfy high demand levels and then reducing the price over time
- This recovers costs quickly and allows for large SR profits
- Demand is more inelastic in the SR, so setting high initial prices ‘skims’ market segments
- The firm must intent to leave the market in the SR
What are Penetration Prices? Provide a small outline of this
- Setting a low price to gain market share and deter any entry, hence making low (possibly negative) profits in the LR
- High PED in the SR
- Significant EoS, entering at a large scale reduces LRAC
- Firm’s objective is to stay in the market in the LR
What does the Product Life Cycle Framework suggest?
- Different pricing points within a product life-cycle
- It should always above the Vc
- Changes in the price is reflected by changes in firm’s objectives
What happens in practice when firms try to price?
- Often firms do not use marginalist principles, do not seek to maximise profits and operate in oligopoly markets
- This means: P = AVC + FC (overheads) + Profit Margin
- AC pricing might be consistent with the profit maximisation model if the profit margin added varies with elasticity
- This isn’t always the case: the method is convenient/simple, safe/reliable and doesn’t account for inflation
How does pricing on the internet work?
- E-business cuts distribution costs, reduces retail margins and introduces effective differential pricing
- Issues include anonymity of buyers/sellers, fraud, poor quality
What are Learning Curves? Describe the graph
- Knowledge gained from experience that can be used to improve the production process, increasing efficiency and reducing costs
- Learning curves reflects AC reduction over time
- This means that the curve shifts downwards and the difference between the curves are the Learning effects
- DMR on AC curve
- Learning Curves help forecast costs, improve pricing decisions and give big firms chances to learn
What are learning rates? Give the formula for this
- Learning Rates: A constant % in AC as cumulative output rises
- This % represents the proportion by which unit costs decline as cumulative output doubles
- L = (1 - AC2/AC1) x 100%
- OR; AC2 = AC1 x (1 - L/100%)
- If the cost function C=aQ^b, it must be made log-linear
When are learning curves the most efficient?
- Learning effects are high
- New industries, new tech/products
- Markets with standardised goods
- Where management controls costs and monitor potential sources of increased productive efficiency
