LECTURE NINE:PRICING

IPEM Tohoku University

Managerial Economics

Lecturer : Jack Wu

Period 1 & 2 /February 18

EMIRATES AIRLINE, DUBAI-MUMBAI, ECONOMY CLASS, MAY 2004

Fare Restrictions Price

Year KRTAE1 None AED 2250

(US$ 613)

Special Excursion QEE4MAE1

Min. 7 days, max. 4 mths stay

AED 1900

Basic Season Special Excursion LLE4MAE1

Low season; min. 7 days, max. 4 mths stay

AED 1550

Basic Season Special Excursion VLE4MAE1

Low season; min. 7 days, max. 4 mths stay

AED 1200

EMIRATES AIRLINE, MUMBAI-DUBAI, ECONOMY CLASS, MAY 2004

Fare Restrictions Price

Economy unrestricted LRT

None INR 25,600

(US$ 557)

Economy restricted LRTIN1

None INR 22,700

Regular Excursion LEE3M1

Min. 7 days, max. 3 mths stay

INR 20,100

Special Excursion VEE3MIN1

Max. 3 mths stay. INR 17,000

EMIRATES AIRLINE

Why does Emirates charge lower fare for passengers originating from Mumbai?

How is this discrimination possible?

PRICING POLICY

uniform pricing complete price discrimination direct segment discrimination indirect segment discrimination bundling

0

30

55

80

2500 5000

marginal revenue

marginal cost

demand

Quantity (Units a year)

Pri

ce (

Thousa

nd Y

en p

er

unit

)

UNIFORM PRICING

UNIFORM PRICING: PROFIT MAXIMUM

MR = MC Equivalently, set the incremental margin

percentage equal to the inverse of absolute value of price elasticity of demand,

(price - MC) / price = -1/e

PRICE ELASTICITY

always set price so that demand is elastic if demand more elastic, then lower

incremental margin percentage (IM%) e = -2 IM% = 1/2

e = -1.5 IM% = 2/3

PRICING PRIVATE-LABEL COLA

Suppose that WalMart learns that demand for private-label cola is less elastic than the demand for Coca Cola. Should WalMart set a higher price for private-label cola?

UNIFORM PRICING: SHORTCOMINGSSHORTCOMINGS

leaves buyers with a lot of surplus

does not sell to every potential buyer

marginal cost

price

buyer surplus

potential buyers

$

0quantity

COMPLETE PRICE DISCRIMINATION

price each unit at buyer’s benefit and sell quantity where MB = MC

� maximum profit -- theoretical ideal

� different from MR = MC implementation: must know entire marginal

benefit and marginal cost curves

COMPLETE PRICE DISCRIMINATION: PRACTICE

bargaining auctions

DIRECT SEGMENT DISCRIMINATION, I

price by segment implementation

� fixed identifiable characteristic --- basic for segmentation

� no re-sale

DIRECT SEGMENT DISCRIMINATION, II

simple case: uniform price within each segment

� within each segment IM% = -1/e� for segment with more elastic

demand, then lower incremental margin percentage (IM%)

0

30

55

80

25003000

Quantity (Units a year)

Pri

ce (

Thousa

nd Y

en p

er

unit

)

(a) Men’s demand

0

30

50

Quantity (Units a year)

Pri

ce (

Thousa

nd Y

en p

er

unit

)

(b) Women’s demand

marginal revenue

demand

40

1000

marginal revenue

demand

marginalcost

DIRECT SEGMENT DISCRIMINATION, III

marg.cost

NYNEX TELEPHONE SERVICE

New York City residential -- $16/month business -- $23/monthHow is discrimination possible?

ASIAN WALL STREET JOURNAL

Price for annual subscription, May 2006

Print: Hong Kong (HK$ 2,700)

US$ 348

Print: Singapore (S$ 525) US$ 331

Print: Tokyo (Yen 94,500) US$ 845

Interactive: Worldwide US$ 99

Why different prices for print edition but not interactive edition?

INDIRECT SEGMENT DISCRIMINATION

structure choice to earn different incremental margins from each segment

implementation seller controls some variable to which segments

are differentially sensitive buyers cannot circumvent the variable

Traveler

Segment

Unrestricted Travel ($)

Restricted Travel ($)

Maria Business 1000 200 Tom Business 900 180 Robin Vacation 500 400 Leslie Vacation 280 224

AIR TRAVEL: BENEFITS

Product

Fare ($)

Sales

Total Rev. ($)

Total Cost ($)

Profit ($)

Unrestricted

900 2 1800 400 1400

Restricted 399 1 399 200 199

*MC=200

AIR TRAVEL: INDIRECT SEGMENT DISCRIMINATION

CHINESE EMBASSY: VISA FEES

Application period

1 day 3 days 7 days

Single entry $75 $60 $25

Double entry $85 $70 $35

Profitability Policy Information Requirement

Highest Complete price discrimination

Highest

Direct segment discrimination

Indirect segment discrimination

Lowest Uniform pricing Lowest

PRICING POLICIES: RANKING

BUNDLING strategy

pure bundling mixed bundling

CABLE TELEVISION: BENEFITS

“if every segment … was wild about one thing and hated the rest, they have done their job” (Economist) Segment Education

channel Music channel

Conservatives $20 $ 2

Middle of road $11 $11

PURE OR MIXED BUNDLING

What is the profit-maximizing pricing policy if marginal cost per channel = 0 marginal cost per channel = $5

PURE OR MIXED BUNDLING Generally, if item is costless, no loss from giving it to

every consumer --> pure bundling; if item is costly, then should avoid providing

it to low-benefit users --> use mixed bundling to screen out low-benefit users.

Mixed bundling is form of indirect segment discrimination

structured choice between bundle and separates