Pricing Strategies

Question 1

Outline the Bertrand model of price competition

Answer 1

Each firm selects a price and meets all demand for its product at that price.

Firm chooses its price to maximise profits, given the price it believes the other firm will select.

Each firm views its rival’s price as fixed

Question 2

What does the Bertrand model not explain?

Answer 2

In some markets firms can maintain prices above competitive levels without formal collusion

In other comparatively concentrated markets price competition is fierce

Question 3

Outline finitely repeated games?

Answer 3

Always an incentive to cheat in the final period

Question 4

Outline infinitely repeated games?

Answer 4

Potential profits from one-time cheating can never outweigh the loss of half the monopoly profits from all future plays of the game.

Question 5

Outline tit-for-tat strategy?

Answer 5

Repeat your opponent’s current move on your next move.

Cooperate on the 1st move; then if your opponent cooperates, you cooperate, if your opponent defects, you defect.

Question 6

Outline the three trade-offs a firm faces when considering undercutting its rivals

Answer 6

1 - Short-term increase in profits, if price decrease translates into an increase in market share.

2 - Long-term increase in profits if, once prices stabilise, it experiences a permanent increase in market share.

3 - If other firms react by lowering prices, original firm may end up with lower profits (no increase in market share and lower price-cost margins)

Question 7

Why may a firm be unable to react quickly?

Answer 7

1 - Lags in detecting competitors pricing

2 - Infrequent interactions with competitors

3 - Difficulties in detecting price moves

4 - Difficulties in detecting whether changes in demand are due to rivals’ price moves or changes in market demand

Question 8

What is the effect of product differentiation on the sustainability of cooperative pricing?

Answer 8

1 - Incentive to cheat is reduced (extent to which lowering prices increases sales depends on the cross-price elasticity of demand)

2 - Punishments may not be as severe; price changes have smaller effect on rival firms

Question 9

Outline price leadership

Answer 9

1 - One firm (the price leader) announces its price changes before all other firms
2 - The other firms then match the leader’s price.
3 - This system can breakdown if the price leader does not retaliate against defectors

Question 10

Outline a ‘most favoured customer clause’

Answer 10

Provision in a sales contract that promises a buyer that it will pay the lowest price the seller charges

These benefit the firms by inhibiting price competition

Question 11

Outline limit pricing

Answer 11

Set a low price to deter entry

Question 12

Outline predatory pricing

Answer 12

Set a very low price to drive competitors out of the market

Question 13

Outline penetration pricing

Answer 13

Set a low price to establish market share

Question 14

Outline loss leader

Answer 14

Set a low price on certain products to stimulate sales of more profitable products

Question 15

Outline price skimming

Answer 15

Release a new product at a high price to capture consumers with inelastic demand. Over time reduce price to capture more price elastic consumers

Question 16

Outline reference pricing

Answer 16

Set a high price to be able to later offer discounts on previously advertised prices

Question 17

Outline Goldilocks pricing

Answer 17

Release three versions of a product at ordered price points, to encourage low-end buyers to trade up to a higher price version (extremeness aversion)

Question 18

Outline premium pricing

Answer 18

Set a high price to limit sales and give the impression that a product is better quality. Designed to change consumer perception of a product

Question 19

Outline price discrimination

Answer 19

Charge different prices to different consumers to take advantage of different elasticities of demand

Question 20

Outline Bundling

Answer 20

Sell several products as a package at a lower price than purchasing the goods individually

Question 21

Outline 1st degree price discrimination

Answer 21

Each unit of the good is sold to the individual who values is most highly, at the maximum price that this individual is willing to pay for it

Question 22

Outline 2nd degree price discrimination

Answer 22

Price per unit of output depends on the quantity purchased

Question 23

Outline 3rd degree price discrimination

Answer 23

Firm sells to different people at different prices, but every unit of the good sold to a given group is sold at the same price