BUS 525: Managerial EconomicsLecture 12Pricing Strategies for Firms with Market PowerOverviewOverviewI. Basic Pricing Strategies Monopoly & Monopolistic Competition Cournot OligopolyII. !tracting Consumer Surplus Price "iscrimination #wo$Part Pricing Bloc% Pricing Commo&ity Bun&lingIII. Pricing 'or Special Cost an& "eman& Structures Pea%$Loa& Pricing #rans'er Pricing Cross Su(si&iesI). Pricing in Mar%ets wit* Intense Price Competition Price Matc*ing +an&omi,e& Pricing Bran& Loyalty11-2Basic +ule 'or Pro'it Ma!imi,ation- Basic +ule 'or Pro'it Ma!imi,ation- an .lge(raic !amplean .lge(raic !ample/ P 0 11 $ 22/ C324 0 22/ I' t*e 'irm must c*arge a single price to all consumers5 t*e pro'it$ma!imi,ing price is o(taine& (y setting M+ 0 MC./ 11 $ 62 0 25 so 27 0 2./ P7 0 11 $ 2324 0 8./ Pro'its 0 384324 $ 2324 0 9:.11-3Stan&ar& Pricing an& Pro'its 'or Stan&ar& Pricing an& Pro'its 'or ;irms wit* Mar%et Power;irms wit* Mar%et PowerPriceQuantityP = 10 - 2Q1086421 234 5MCMR = 10 - 4QProfits from standard pricin= !811-4. Simple Mar%up +ule. Simple Mar%up +ule/ Suppose t*e elasticity o' &eman& 'or t*e 'irm ;4? ;@./ Setting M+ 0 MC an& simpli'ying yiel&s t*is simple pricing 'ormula-P 0 =;?31> ;4@ MC./ #*e optimal price is a simple mar%up over relevant costsA More elastic t*e &eman&5 lower mar%up. Less elastic t*e &eman&5 *ig*er mar%up. Big*er t*e marginal cost *ig*er t*e price* for a firm with market power 11-5.n !ample.n !ample/ lasticity o' &eman& 'or Co&a% 'ilm is $2./ P 0 =;?31> ;4@ MC/ P 0 =$2?31 $ 24@ MC/ P 0 2 MC/ Price is twice marginal cost./ ;i'ty percent o' Co&a% DM4@ MC. #*e greater t*e num(er o' 'irms5 t*e lower t*e pro'it$ma!imi,ing mar%up 'actor. More elastic t*e mar%et &eman&5 closer P wit* MC Big*er MC5 *ig*er pro'it ma!imi,ing price un&er Cournot oligopoly11-7.n !ample.n !ample/ Bomogeneous pro&uct Cournot in&ustry5 E 'irms./ MC 0 911./ lasticity o' mar%et &eman& 0 $ F./ "etermine t*e pro'it$ma!imi,ing priceG/ ; 0 D M 0 E 3$1?24 0 $1.H./ P 0 =;?31> ;4@ MC./ P 0 =$1.H?31$ 1.H@ 911./ P 0 E 911 0 9E1.11-8!tracting Consumer Surplus- !tracting Consumer Surplus- Moving ;rom Single Price Mar%etsMoving ;rom Single Price Mar%ets/ Most mo&els e!amine& to t*is point involve a IsingleJ eKuili(rium price. / In reality5 t*ere are many &i''erent prices (eing c*arge& in t*e mar%et./ Price &iscrimination is t*e practice o' c*arging &i''erent prices to consumer 'or t*e same goo& to ac*ieve *ig*er prices./ #*e t*ree (asic 'orms o' price &iscrimination are- ;irst$&egree 3or per'ect4 price &iscrimination. Secon&$&egree price &iscrimination. #*ir&$&egree price &iscrimination.11-9 ;irst$"egree or Per'ect ;irst$"egree or Per'ect Price "iscriminationPrice "iscrimination/ Practice o' c*arging eac* consumer t*e ma!imum amount *e or s*e will pay 'or eac* incremental unit./ Permits a 'irm to e!tract all surplus 'rom consumers.11-10Per'ect Price "iscriminationPer'ect Price "iscriminationPrice Quantity"108642123 45 Profits*:#5$4-0%$10 - 2%= !16Total Cost* = $8MC& 'ssumin no fi(ed costs11-11Caveats-Caveats-/ In practice5 transactions costs an& in'ormation constraints ma%e t*is &i''icult to implement per'ectly 3(ut car &ealers an& some pro'essionals come close4./ Price &iscrimination won Ns4@ MC 0 =$1.H?31 $ 1.H4@ 9E 0 9P/ PO 0 =O?31> O4@ MC 0 =$2.H?31 $ 2.H4@ 9E 0 9H/ .pe!