MANAGERIAL MANAGERIAL ECONOMICS 11ECONOMICS 11thth Edition Edition

ByBy

Mark HirscheyMark Hirschey

Pricing PracticesPricing Practices

Chapter 15Chapter 15

Chapter 15Chapter 15OVERVIEWOVERVIEW

Pricing Rules-of-thumb Markup Pricing And Profit Maximization Price Discrimination Price Discrimination Example Multiple-product Pricing Joint Products Joint Product Pricing Example Transfer Pricing Global Transfer Pricing Example

Chapter 15Chapter 15KEY CONCEPTSKEY CONCEPTS

competitive market pricing rule-of-thumb

imperfectly competitive pricing rule-of-thumb

markup on cost profit margin optimal markup on cost markup on price optimal markup on

price Lerner Index of

Monopoly Power price discrimination

market segment first-degree price

discrimination second-degree price

discrimination third-degree price

discrimination by-product common costs vertical relation vertical integration transfer pricing

Pricing Rules-of-thumb

Competitive Markets Profit maximization always requires

setting Mπ = MR - MC = 0, or MR=MC, to maximize profits.

In competitive markets, P=MR, so profit maximization requires setting P=MR= MC.

Imperfectly Competitive Markets With imperfect competition, P > MR, so profit

maximization requires setting MR=MC. MR = P[1 + (1/εP)] Optimal P* = MC/[1 + (1/εP)]

Markup Pricing And Profit Maximization

Optimal Markup on Cost Markup on cost uses cost as a basis. Markup pricing is an efficient means for

achieving the profit maximization objective.

Optimal markup on cost = -1/(εP + 1)

Optimal Markup on Price Markup on price uses price as a basis. Optimal markup on price = -1/εP

Price Discrimination Profit-Making Criteria

Price discrimination exists if P1/P2 ≠ MC1/MC2. Ability to segment the market. Multiple markets with no reselling. Price elasticity of demand differs across

submarkets. Degrees of Price Discrimination

First degree: Different prices for each consumer. Creates maximum profits for sellers.

Second degree: Block‑rates or quantity discounts. Third degree: Different prices by customer age,

sex, income, etc. (most common).

Price Discrimination Example

Price/Output Determination Maximizes profits by setting MR=MC in each

market segment. One-price Alternative

Without price discrimination, MR=MC for customers as a group.

With price discrimination, MR=MC for each customer or customer segment.

Profitable price discrimination benefits sellers at the expense of some customers.

Graphic Illustration

Multiple-product Pricing

Demand Interrelations Cross‑marginal revenue terms indicate

how product revenues are related to another.

Production Interrelations Joint products may compete for resources

or be complementary. A by-product is any output customarily

produced as a direct result of an increase in the production of some other output.

Joint Products

Joint Products in Variable Proportions If products are produced in variable

proportions, treat as distinct products. For joint products produced in variable

proportions, set MRA=MCA and MRB=MCB. Common costs are joint product expenses.

Allocation of common costs is wrong and arbitrary.

Joint Products in Fixed Proportions Some products are produced in a fixed ratio. If Q=QA=QB, set MRQ=MRA+MRB=MCQ.

Joint Product Pricing Example

Joint Products Without Excess By-product Profit-maximization requires setting

MRQ=MRA+MRB=MCQ. Marginal revenue from each byproduct makes a

contribution toward covering MCQ.

Joint Production With Excess By-product (Dumping) Profit-maximization requires setting

MRQ=MRA+MRB=MCQ. Primary product marginal revenue covers MCQ. Byproduct MR=MC=0.

Transfer Pricing Transfer Pricing Problem

Pricing transfer of products among divisions of a single firm can become complicated.

Products Without External Markets Marginal cost is the appropriate transfer price.

Products With Competitive External Markets Market price is the optimal transfer price.

Products With Imperfectly Competitive External Markets Optimal transfer price is the marginal revenue

derived from combined internal and external markets.

Global Transfer Pricing Example

Profit Maximization for an Integrated Firm Optimal transfer price is profit maximizing.

Transfer Pricing with No External Market Optimal transfer price balances supply/demand.

Competitive External Market with Excess Internal Demand Firm employs own and external inputs.

Competitive External Market with Excess Internal Supply Firm supplies inputs to internal and external

markets.