CH12 PPT

3/22/2018
Microeconomics
Eighth Edition, Global Edition
Chapter 12
Pricing and
Advertising
Copyright © 2018 Pearson Education, Ltd. All Rights Reserved
Learning Objectives
12.1 Conditions for Price Discrimination.
12.2 Perfect Price Discrimination.
12.3 Group Price Discrimination.
12.4 Nonlinear Price Discrimination.
12.5 Two-Part Pricing.
12.6 Tie-In Sales.
12.7 Advertising.
Pricing and Price Discrimination

• Uniform pricing - charging the same price for every
unit sold of a particular good.
• Nonuniform pricing - charging consumers different
prices for the same product or charging a single
customer a price that depends on the number of units
the customer buys.
• Price discrimination - practice in which a firm
charges consumers different prices for the same
good.
1
3/22/2018
Why Price Discrimination Pays

• A price-discriminating firm earns a higher profit from
price discrimination because:
– it charges a higher price to customers who are willing
to pay more than the uniform price, capturing some or
all of their consumer surplus.
– it sells to some people who were not willing to pay as
much as the uniform price.
A Theater’s Profit Based on the

Pricing Method Used (1 of 2)
Table 12.1 A Theater’s Profit Based on the Pricing Method Used
(a) No Extra Customers from Price Discrimination
Profit from 10 Profit from 20

Pricing College Students Senior Citizens Total Profit
Uniform, $5 $50 $100 $150
Uniform, $10 $100 $0 $100
Price discrimination* $100 $100 $200
A Theater’s Profit Based on the

Pricing Method Used (2 of 2)
[Table 12.1 Continued]
(b) Extra Customers from Price Discrimination
Profit from 10 Profit from 5

Pricing College Students Senior Citizens Total Profit
Uniform, $5 $50 $25 $75
Uniform, $10 $100 $0 $100
Price discrimination* $100 $25 $125
*The theater price discriminates by charging college students $10 and

senior citizens $5.
Notes: College students go to the theater if they are charged no more
than $10. Senior citizens are willing to pay at most $5. The theater’s
marginal cost for an extra customer is zero.
2
3/22/2018
Which Firms Can Price Discriminate

• Three conditions:
– a firm must have market power.
– Groups of consumers or individual consumers must
have demand curves that differ, and a firm must be
able to identify how its consumers’ demand curves
differ.
– a firm must be able to prevent or limit resale.
Preventing Resale
• Resale is difficult or impossible for most services and
when transaction costs are high.
• Some firms act to raise transaction costs or otherwise
make resale difficult.
• A firm can prevent resale by vertically integrating:
participating in more than one successive stage of the
production and distribution chain for a good or service.
• Governments frequently aid price discrimination by
preventing resale.
Not All Price Differences Are Price

Discrimination
• Not every seller who charges consumers different
prices is price discriminating.
3
3/22/2018
Types of Price Discrimination (1 of 3)

• Perfect price discrimination (first-degree price
discrimination) - situation in which a firm sells each
unit at the maximum amount any customer is willing to
pay for it, so prices differ across customers and a
given customer may pay more for some units than for
others.

• Nonlinear price discrimination (second-degree
price discrimination) - situation in which a firm
charges a different price for large purchases than for
small quantities, so that the price paid varies
according to the quantity purchased.

• Group price discrimination (third-degree price
discrimination) - a situation in which a firm charges
each group of customers a different price, but it does
not charge different prices within the group.
4
3/22/2018
Perfect Price Discrimination

• If a firm with market power knows exactly how much
each customer is willing to pay for each unit of its
good and it can prevent resale, the firm charges each
person his or her reservation price.
• Reservation price - the maximum amount a person
would be willing to pay for a unit of output.
Figure 12.1 Perfect Price

Discrimination
Perfect Price Discrimination Is

Efficient But Harms Some Consumers
• Perfect price discrimination is efficient: It maximizes
the sum of consumer surplus and producer surplus.
• Both perfect price discrimination and perfect
competition maximize total surplus. However, with
perfect price discrimination, the entire surplus goes to
the firm, whereas the surplus is shared under
competition.
5
3/22/2018
Figure 12.2 Competitive, Single-Price,

and Perfect Discrimination Equilibria
Application: Botox and Price

Discrimination
Solved Problem 12.1

• How does welfare change if the movie theater
described in Table 12.1 goes from charging a single
price to perfectly price discriminating?
• Answer:
1. Calculate welfare for panel a (a) if the theater sets a
single price and (b) if it perfectly price discriminates,
and then (c) compare them.
2. Calculate welfare for panel b (a) if the theater sets a
single price and (b) if it perfectly price discriminates,
and then (c) compare them.
6
3/22/2018
Transaction Costs and Perfect Price

Discrimination
• Although some firms come close to perfect price
discrimination, many more firms set a single price or
use another nonlinear pricing method.
• Transaction costs are a major reason why these firms
do not perfectly price discriminate:
– It is too difficult or costly to gather information
about each customer’s price sensitivity.
Group Price Discrimination

• A firm engages in group price discrimination by
dividing potential customers into two or more groups
and setting different prices for each group.
• Consumer groups may differ by age (such as adults
and children), by location (such as by country), or in
other ways.
Group Price Discrimination with Two

Groups (1 of 3)
   A   B   pAQA  mQA    pBQB  mQB 
• pAQA is the U.S. revenue

• pBQB is the U.K. revenue
• mQA is the U.S. cost
• mQB is the U.K. cost
• Warner sets its quantities so that the marginal revenue for
each group equals the common marginal cost, m, which is
about $1 per unit.
7
3/22/2018

Groups (2 of 3)
• Because the monopoly equates the marginal revenue
for each group to its common marginal cost,
MR A  m  MR B .
‒ Therefore, using price elasticities:
 1  1
MR A  pA  1    m  pB  1    MR B
 A   B 

Groups (3 of 3)
• From previous slide:
 1  1
MR A  pA  1    m  pB  1    MR
B
  A    B 
– and rearranging,
1 1
pB A

pA 1  1
B
Figure 12.3 Group Pricing of the

Harry Potter DVD
8
3/22/2018
Solved Problem 12.2

• We estimate that Warner faced inverse demand
functions for its Harry Potter and the Deathly
Hallows, Part 2 DVD of pA = 57 – 4.8QA in the United
States and pB = 77 – 19QB in the United Kingdom.
Given that the marginal cost is 1 in both countries,
solve for Warner’s optimal prices and quantities in
each country.
Solved Problem 12.2: Answer

1. Determine the marginal revenue functions. The
marginal revenue curve corresponding to a linear
inverse demand curve has twice as steep a slope
and the same price intercept.
2. Solve for Warner’s optimal monopoly prices and
quantities in each country separately. Warner’s
optimal monopoly quantity is determined by
equating the marginal revenue and marginal cost.
Solved Problem 12.3

• What U.S. and U.K. elasticities did Warner Brothers
believe it faced for its Happy Potter and the Deathly
Hallows, Part 2 DVD? Check that these elasticities
are consistent with the observed price ratio,
pA
.
pB
9
3/22/2018
Solved Problem 12.4

• A monopoly book publisher with a constant marginal
cost (and average cost) of MC = 1 sells a novel in only
two countries and faces a linear inverse demand
curve of p1 = 6 − 0.5Q1 in Country 1 and p2 = 9 − Q2 in
Country 2. What price would a profit-maximizing
monopoly charge in each country with and without a
ban against shipments between the countries?
Identifying Groups
• Two approaches to divide customers into groups:
– divide buyers into groups based on observable
characteristics of consumers.
– identify and divide consumers on the basis of their
actions.
10
3/22/2018
Application: Buying Discounts

• Firms use various approaches to induce consumers to
indicate whether they have relatively high or low
elasticities of demand.
• By spending extra time to obtain a discount, price-
sensitive consumers are able to differentiate
themselves.
– Coupons
– Airline Tickets
– Reverse Auction
– Rebates
Welfare Effects of Group Price

Discrimination
• Group price discrimination results in inefficient
production and consumption.
• Welfare under group price discrimination is lower than
that under competition or perfect price discrimination.
• However, welfare may be lower or higher with group
price discrimination than with a single-price monopoly.
Nonlinear Price Discrimination

• Most customers are willing to pay more for the first
unit than for successive units:
– the typical customer’s demand curve is downward
sloping.
• Block-pricing schedules - charge one price for the
first few units (a block) of usage and a different price
for subsequent blocks.
11
3/22/2018
Figure 12.4 Block Pricing
Two-Part Pricing
• Two-part pricing - a pricing system in which the firm
charges a customer a lump-sum access fee for the
right to buy as many units of the good as the
consumer wants at a per-unit price.
A Two-Part Pricing with Identical

Consumers
• A monopoly that knows its customers’ demand curve
can set a two-part price that has the same two
properties as the perfect price discrimination
equilibrium.
• The efficient quantity is sold because the price of the
last unit equals marginal cost.
• All consumer surplus is transferred from consumers to
the firm.
12
3/22/2018
Figure 12.5 Two-Part Pricing with

Identical Consumers
A Two-Part Pricing with Nonidentical

Consumers (1 of 2)
• The monopoly charge a price above marginal
cost.
• By raising its price, the monopoly earns more per
unit from both types of customers but lowers its
customers’ potential consumer surplus.
A Two-Part Pricing with Nonidentical

Consumers (2 of 2)
• Thus, if the monopoly can capture each customer’s
potential surplus by charging different lump-sum fees,
it sets its price equal to marginal cost.
• However, if the monopoly must charge everyone the
same lump-sum fee, the increase in profit from
Customer 2 from the higher price more than offsets
the reduction in the lump-sum fee.
13
3/22/2018
Figure 12.6 Two-Part Pricing with

Different Consumers
Application: iTunes for a Song (1 of 2)

• In 2009 Apple’s iTunes online music store switched to
nonuniform pricing.
• Did Apple’s one-price-for-all-songs policy cost it
substantial potential profit?
• Shiller and Waldfogel (2011) surveyed nearly 1,000
students and determined each person’s willingness to
pay for each of 50 popular songs.
• Then they used this information to calculate a firm’s
optimal pricing under various pricing schemes.
Application: iTunes for a Song (2 of 2)
Pricing PS CS |DWL|
Uniform 28 42 29
Variable 29 45 26
Two-part pricing 37 43 20
14
3/22/2018
Tie-In Sales (1 of 2)
• Tie-in sale - a type of nonlinear pricing in which
customers can buy one product only if they agree to
buy another product as well.
• Requirement tie-in sale - a tie-in sale in which
customers who buy one product from a firm are
required to make all their purchases of another
product from that firm
Tie-In Sales (2 of 2)
• Bundling (package tie-in sale) - a type of tie-in sale
in which two goods are combined so that customers
cannot buy either good separately.
• Bundling a pair of goods pays only if their demands
are negatively correlated.
Negatively Correlated Reservation

Prices
Table 12.2 Negatively Correlated Reservation Prices
Blank Word Processor Spreadsheet Bundle
Alisha $120 $50 $170
Bob $90 $70 $160
Profit-maximizing price $90 $50 $160
Units sold 2 2 2
15
3/22/2018
Positively Correlated Reservation

Prices
Table 12.3 Positively Correlated Reservation Prices
Carol $100 $90 $190
Dmitri $90 $40 $130
Profit-maximizing price $90 $90 $130
Units sold 2 2 2
Solved Problem 12.5 (1 of 2)

• A firm that sells word processing and spreadsheet
programs has four potential customers with the
following reservation prices:
Aaron $120 $30 $150
Brigitte $110 $90 $200
Charles $90 $110 $200
Dorothy $30 $120 $150
Solved Problem 12.5 (2 of 2)

• The firm’s cost of production is zero, so maximizing its
profit is equivalent to maximizing its revenue. To
maximize its profit, should the firm charge separate
prices for each product, engage in pure bundling, or
use mixed bundling?
16
3/22/2018

1. Calculate the profit-maximizing separate service
prices and the resulting profit.
2. Calculate the profit-maximizing pure bundle price
and the resulting profit.
3. Determine how the firm maximizes its profit by using
mixed bundling.
Advertising
• A monopoly advertises to raise its profit.
• A successful advertising campaign shifts the market
demand curve by changing consumers’ tastes or
informing them about new products.
The Decision Whether to Advertise

• Even if advertising succeeds in shifting demand, it
may not pay for the firm to advertise.
• If advertising shifts demand outward, the firm’s gross
profit must rise.
• The firm undertakes this advertising campaign only if
it expects its net profit (gross profit minus the cost of
advertising) to increase.
17
3/22/2018
Figure 12.7 Advertising
How Much to Advertise

• The rule for setting the profit-maximizing amount of
advertising is the same as that for setting the profit
maximizing amount of output: Set advertising or
quantity where the marginal benefit (the extra gross
profit from one more unit of advertising or the marginal
revenue from one more unit of output) equals its
marginal cost.
Figure 12.8 Shift in the Marginal

Benefit of Advertising
18

CH12 PPT

Uploaded by

Copyright:

Available Formats

CH12 PPT

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

CH12 PPT

Uploaded by

Copyright:

Available Formats

3/22/2018

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved

Pricing and Price Discrimination

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved

Why Price Discrimination Pays

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved

A Theater’s Profit Based on the

Profit from 10 Profit from 20

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved

A Theater’s Profit Based on the

Profit from 10 Profit from 5

*The theater price discriminates by charging college students $10 and

Which Firms Can Price Discriminate

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved

Not All Price Differences Are Price

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved

Types of Price Discrimination (1 of 3)

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved

Types of Price Discrimination (2 of 3)

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved

Types of Price Discrimination (3 of 3)

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved

Perfect Price Discrimination

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved

Figure 12.1 Perfect Price

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved

Perfect Price Discrimination Is

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved

Figure 12.2 Competitive, Single-Price,

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved

Application: Botox and Price

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved

Solved Problem 12.1

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved

Transaction Costs and Perfect Price

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved

Group Price Discrimination

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved

Group Price Discrimination with Two

• pAQA is the U.S. revenue

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved

Group Price Discrimination with Two

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved

Group Price Discrimination with Two

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved

Figure 12.3 Group Pricing of the

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved

Solved Problem 12.2

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved

Solved Problem 12.2: Answer

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved

Solved Problem 12.3

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved

Solved Problem 12.4

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved

Solved Problem 12.4: Answer

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved