Week 6

Question 1

what are prices determined by?

Answer 1

a wide range of factors, demand and supply, market structures and the aims of managers

Question 2

what will firms with market power not always attempt in the short tern?

Answer 2

to maximise short run profits, even if maximum profits is the aims. they may well limit prices as to forestall the entry of new firsm

Question 3

what does traditional economic theory assume?

Answer 3

that businesses will set prices corresponding to the output where the marginal costs of production are equal to marginal revenue and they will do so in pursuit of maximum profits

Question 4

what is cost-based pricing?

Answer 4

it involves the business adding a profit mark-up to its average costs of production. the profit mark-up set by the business is likely to alter depending on market conditions such as consumer demand and the degree of market competition

Question 5

why do many businesses practice price discrimination?

Answer 5

in an attempt to maximise profits from the sale of a product. there are different types of price discrimination that a business might practice

Question 6

what is first degree price discrimination?

Answer 6

where the consumer is charged the maximum he or she is prepared to pay.

Question 7

what is second degree price discrimination?

Answer 7

the same consumer is charged different prices according to the amount, timing or other features of the purchase

Question 8

what is third degree price discrimination?

Answer 8

where consumers are divided into groups and the group with the lower price elasticity of demand are charged the higher price

Question 9

for a business to practice price discrimination, what must it be able to do?

Answer 9

set prices and separate markets so as to prevent resale from the cheap to the expensive market. also, consumers must have different price elasticities of demand that the firm can exploit in its pricing

Question 10

is price discrimination in the consumers interest?

Answer 10

its not certain, some will gain and some will lose
- businesses that produce many products need to consider the demand and production interrelations between when setting prices

Question 11

what is the optimum transfer price?

Answer 11

the optimum price between divisions from the point of view of the whole organisation is likely to be equal to marginal cost

Question 12

why will products be priced differently?

Answer 12

depending upon where they are in the products lifecycle

Question 13

why can products be priced cheaply?

Answer 13

to gain market share or priced expansively to recoup cost. later on in the products life cycle, prices will have to reflect the degree of competition, which may become intense as the market stabilises or even decisions

Question 14

what price discrimination?

Answer 14

where a firm sells the same or similar product at different prices and the difference in price cannot be fully accounted by any differences in the costs of supply

Question 15

what is limit pricing?

Answer 15

where a business strategically sets its price below the level that would maximise its profits in the short run in an attempt to deter new rivals entering the market, enables them to make greater profit in the long run
COMPETITOR PRICING

Question 16

what is mark-up pricing?

Answer 16

a pricing strategy adopted by business in which a profit mark-up is added to average costs

Question 17

what is reverse capacity?

Answer 17

a range of output over which business costs will tend to remain constant

Question 18

what is inter-temporal pricing?

Answer 18

when the price a firm charged for a product varies over time, it occurs where the price elasticity of demand for a product varies at different points in time

Question 19

what affects the level of profit mark-up?

Answer 19

its influenced by a range of possible considerations such as fairness and response of rivals, the implications of price for the level of market demand

Question 20

why are there variations in mark up?

Answer 20

the market conditions a firm is in affects the mark up, eg in monopoly and oligopoly, the size of the mark up will be greater

Question 21

what are the benefits and disadvantages of cost plus ‘mark up’ pricing?

Answer 21

BEN:
-if a firm knows its total (or even variable costs) it is easily
estimable.
- Andrews (1949) it takes account of market: the mark-up set in practice regards both cost and demand conditions – therefore may come to approximate the optimal price (price for output where MC=MR).
- Prices likely to be stable: as in practice firms will try to boost
sales by some form of sales effort rather than by cutting prices.
DISADV:
-a) Which cost to use?
* Firms should use AC but if hard to observe some firms may
use AVCs (then Accountants call it “marginal costing”).
b) How much of costs to attribute to multiple products?
* Firm has to decide how much of the cost of e.g. machinery
and/or labour to attribute to each product.
c) Firm has to decide what is their NORMAL level of output.
* As output increases, economies of scale/scope cause average
unit cost to fall, i.e. Problem of ‘CAPACITY UTILISATION’.
d) What mark-up to use?
* How much profit mark-up will the market bear?

Question 22

what is competitor pricing?

Answer 22

Firms may change their prices to:
a) protect their market share by;-
* Parallel pricing (move price with or parity with competitor)
* Limit pricing
or
b) increase their market share
* Competitive versus Predatory pricing

Question 23

what are the limitations to competitor pricing?

Answer 23

Limitations to success (predatory pricing):
* Competitors may rally more reserves than originally thought
* Competitors may find some innovative way to sustain.
* If current competitors are removed, the predator company
may be weakened and more competitors may enter.

Empirical evidence shows:
* Larger firms pay more attention to market share (competitive)
pricing. Particularly homogeneous goods with low/no brand
loyalty.
* Very few firms “predatory pricing” strategy prosecuted.

Question 24

what are the conditions necessary for all types of price discrimination?

Answer 24

1. firm must have some market power: have a downward facing demand curve, price discrimination isn’t possible under perfect competition where firms are price taker
2. resale of the product must not be possible between consumers
3. demand elasticity must vary between consumers at any given price
4. a means of separation
5. lack of price competition

Question 25

what are the four classic ways in which markets can be segmented
and price discrimination implemented?

Answer 25

1. Socio-economic factors.
   * E.g. students, OAPs, etc.
2. Time
   * E.g. peak/off peak (only if the product is non-storable).
3. Location
   * Price discrimination is sometimes practised over different
   international markets.
4. Product type or use
   * E.g. providing ‘extras’ in a higher priced version.

Question 26

what factors need to be taken into account when thinking about price discrimination?

Answer 26

1. distribution effects on those consumers who previously purchased the good at a uniform price
2. the impact of any extra sales - eg people who previously couldnt afford it but can now
3. misallocation effects - implementation of third degree discrimination could mean some units being reallocated away from those consumer with a higher willingness to pay to those with a lower willingness
4. competition effects: However, price discrimination could take place in an oligopolistic market. In this case, it is possible that a firm may use price discrimination to drive competitors out of business. This is known as predatory pricing . Under this practice, a company charges a price below average cost in one market by cross-subsidising that part of the business with profits from another part of the business. It does this until its rival stops competing in that market.

Question 27

what is predatory pricing?

Answer 27

where a firm sets its average price below average cost in order to drive competitors out of business
COMPETITOR PRICING

Question 28

what is a loss leader?

Answer 28

a product whose price is cut by the business in order to attract custom

Question 29

what is transfer pricing?

Answer 29

the pricing system used within a business organisation to transfer intermediate products between the business various divisions

Question 30

what does the decentralisation of pricing and output decision making cause?

Answer 30

the decentralisation of pricing and output decision making can become problematic. This is particularly the case when the various divisions within the firm represent distinct stages in the production process. In these instances, certain divisions may well produce intermediate products that they will sell to other divisions within the business. There then arises the difficulty of how such intermediate products should be priced. This is known as the problem of transfer pricing

Question 31

what is an implication of transfer pricing?

Answer 31

a division that is seeking to maximise its own profits when selling to another division will attempt to exploit its ‘monopoly’ position and increase the transfer price. As it does so, the purchasing division, unless it, in turn, can pass on the higher cost, will see its profits fall. Indeed, if it could, the purchasing division would seek to drive down the purchase price as low as possible

Question 32

what are the four stages with life cycle of a product?

Answer 32

1. LAUNCH: Firm likely has monopoly, high prices, high profits, low output
2. Growth: High profit attracts firms. Likely oligopoly
   3.Maturity: Large market, many competing firms, low profit, low price. Firms likely competing on product characteristics – i.e. monopolistic comp
   4.Decline: Saturated market, superior products superseding older. Lowest prices, lowest profit

Question 33

in the launch and growth phase what type of pricing strategy can they take?

Answer 33

Can take EITHER ‘Skimming’ OR Penetration pricing
approach
‘Skimming’ (A form of intertemporal price discrimination)
* High initial price to ‘skim the cream’ i.e. consumers with high
WTP. (e.g. fashion, new tech which have short life cycle).
* Price then lowered over time as customers with the most
inelastic demand have been picked off.

Question 34

what conditions are needed for skimming approach?

Answer 34

Conditions required for skimming strategy:
1. Superior product - must have sufficient appeal to attain premium price;
2. Inelastic demand in a viably large part of the demand curve
3. Protection - Competiton can’t be easy, i.e. legal protection (IP) or difficult to copy;
4. Limited production viability - Any cost penalty from restricting volume can’t outweigh higher price revenues;

Question 35

what conditions are needed for penetration pricing? what are the reasons to pursue this?

Answer 35

‘Penetration pricing’
* Set initial low price in order to achieve maximum market penetration. (Given
sufficient price elasticity)
* Once penetration achieved, then raise the prices (e.g. Ferrero Roche chocolates).

Reasons to pursue penetration strategy:
* Limits threat of entry
* Establishes a strong market position, i.e. brand loyalty.
* Benefit from economies of scale earlier (due to high volume).
* Benefit from ‘learning curve’ effects from increasing output.

Question 36

what is the price charged in the maturity phase depend on?

Answer 36

The price charged will be dependent on:
* Market share already established
* The quality of their product relative to their competitors

Firms often tend to bring out “New Improved Versions” of the same product to prolong their market share
* e.g. Procter & Gamble cleaning products, disposable nappies.
If the firm has established itself with a large market share and a reputation for higher quality, then they tend to charge a higher price to ‘cash-in’

Question 37

what is the price charged in the decline phase depend on?

Answer 37

• Firms could still charge a higher price hoping that their customers remain loyal.
• Also they may try to re-version, or re-pack the old products as “CLASSIC” e.g. Video
  games like “Doom” and “Quake”
• Leave the market.

Question 38

what is product line pricing?

Answer 38

Firms producing (or retailing) a range of products with interrelated
demand:
* If demand for products is linked independent pricing may not offer the most attractive package to consumers
* e.g. go into a supermarket or a DIY store, buy more than one product
* Better to consider full-range pricing
* E.g. setting lower prices on some goods and higher on others (will lead to higher overall profit), like burgers & sodas.
* Or bundling products (e.g. garden tool set)
* Common approach is use of loss leaders (an individual product sold at a loss to entice in custom)

Question 39

what is prestige pricing?

Answer 39

• Here advertising, branding, customer service etc. persuades customers that paying a higher price means better quality.
• Can sustain higher prices

Question 40

what is full range pricing?

Answer 40

A pricing strategy in which a business, seeking to improve its profit performance, assesses the pricing of its goods as a whole rather than individually.

Question 41

what is price based on market segmentation like?

Answer 41

-Firms create/ capture market segments and can charge a
higher price in that segment.

-Information Technology has increased sophistication of
segmentation

Question 42

what decides what price to pitch a product?

Answer 42

• Depends on attributes or characteristics (see lecture 2).
• Consumers demand products because of an underlying
  demand for the attributes. Products with more desirable attributes should theoretically command higher prices.
• In market analysis one method is to construct a ‘buy-
  response’ curve.
• A variant is the ‘multi-brand test’ where consumers are
  asked how much more they would be prepared to pay for an
  extra feature.
• Create products which are closely related but advertising and
  promotion have allowed a brand to be differentiated.
  Market research is important to make this successful.

Question 43

what does microeconomic theory determine so far?

Answer 43

So far microeconomic theory determines that:
* A Profit-maximising firm will choose a price coresponding
to the output where: MC = MR.
* However, for firms in Oligopoly, price tends to be STICKY
as they compete on non-price factorss