ECN2014 MANAGERIAL ECONOMICS

DEPARTMENT OF ECONOMICS & FINANCE, SUBS

LECTURE
PRICING TECHNIQUES
 LEARNING OUTCOMES

By the end of this lecture, student should be able to:

1. Describe different PRICING TECHNIQUES – Uniform pricing, Price discrimination
and pricing technique for a multiple-product firm which are relevant to
managerial decision-making.
2. Demonstrate how the different PRICING TECHNIQUES are dealt with real
business scenarios via using Graphical and Quantitative tools and,
3. Recognize the LIMITATIONS of COST-PLUS PRICING TECHNIQUE.

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 DIFFERENT PRICING TECHNIQUES

‘Uniform pricing occurs when businesses charge the same price for
every unit of the product they sell. Price discrimination is a more
profitable alternative to uniform pricing, if market conditions allow this
practice to be profitably executed.’

‘Price discrimination is the technique of charging different prices for

the same product for the purpose of capturing consumer surplus,
turning consumer surplus into economic profit.’
Quoted from Thomas & Maurice Student Workbook

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 PRICE DISCRIMINATION

Price discrimination between two products A and B exists when the price-
to-marginal cost ratio differs between products:
𝑃𝐴 𝑃𝐵
≠
𝑀𝐶𝐴 𝑀𝐶𝐵

To practice price discrimination profitably, THREE conditions are necessary:

I. the firm must possess some degree of market power,
II. a cost-effective means of preventing resale between lower-price and
higher price buyers must be implemented, and
III. price elasticities must differ between individual buyers or groups of
buyers.
Quoted from Thomas & Maurice Student Workbook

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DIFFERENT FORMS OF PRICE DISCRIMINATION
Under first-degree price discrimination, the discriminating firm examines each
individual’s demand separately, and charges each consumer the maximum price
he or she is willing to pay for every unit.
When the same consumer buys more than one unit of a good or service at a time,
the marginal value placed on consuming additional units declines as more units
are consumed. Second-degree price discrimination takes advantage of this falling
marginal valuation by reducing the average price as the amount purchased
increases: (i) two-part pricing, and (ii) declining block pricing.
If a firm sells in two distinct markets (1 and 2) i.e. practices third-degree price
discrimination– then it should allocate output (sales) between the two markets
based on the equal-marginal-revenue principle i.e. MR1 = MR2. Hence, the more
elastic market getting the lower price and the less elastic market getting the higher
price: If E1> E2, then P1< P2.

Quoted from Thomas & Maurice Student Workbook

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PRICE DISCRIMINATION
Refer to Thomas & Maurice textbook, Applied problem 12, pp.622.
Given PBLOUSE
A woman > PSHIRT by
complained to $2.25,
“Dear there
Abby” isthat
a PRICE DISCRIMINATION
a laundry charged
$1.25 each to laundry, and 𝑃𝐵𝐿𝑂𝑈𝑆𝐸
iron her husband’s 𝑃shirts,
𝑆𝐻𝐼𝑅𝑇 but for her
if MCBLOUSE = MC SHIRT making ≠ .
shirts - the same description, only 𝑀𝐶𝐵𝐿𝑂𝑈𝑆𝐸 𝑀𝐶𝑆𝐻𝐼𝑅𝑇
smaller, the laundry charged
$3.50. When asked why, the owner said, “Women’s blouses cost
Based on
more.” Abby thesuggested
equal-marginal-revenue principle
sending all the shirts in onei.e. MR1 and
bundle = MR2,
the more elastic
enclosing a note market
saying, getting
“There the
are lower price and
no blouses here.the less are
These elastic
market
all getting the higher price. In this case, The result of PBLOUSE >
shirts.”
PSHIRT shows that EMAN> EWOMEN. ???
a. Is the laundry practicing price discrimination, or is there
really E
However, a $2.25 difference
seems to bein more
cost? elastic for two reasons:
WOMEN
▪b. More substitutes
Assuming – home is
the laundry laundering
engaging in price discrimination,
▪ Women
why dohave
men apay
higher proportion
the lower priceof
andincome spent
women on laundry than that by men.
higher?
c. Could the laundry continue to separate markets if people
followed Abby’s advice? What about the policing costs
associated with separating the markets?
Seems difficult to separate between two market for a laundry.
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 Refer to Student workbook, Homework exercises, pp. 319

Marvel Cleaning Service, Inc. is a firm that specializes in

cleaning business offices, and Marvel enjoys a
DIFFERENT monopoly position because it is the only firm allowed to
provide cleaning service at the TechCenter industrial office
PRICING park – the monopoly is believed to enhance security. There
are 25 equal-sized offices in TechCenter, each one leased
TECHNIQUES to a different company. TechCenter is closed 45 days a
year (Sundays plus official federal holidays), which limits
the demand for Marvel’s cleaning services to a maximum
7 of 320 cleanings per year for each one of the 25
companies leasing offices.
Marvel believes it faces an identical demand by each one
of the 25 businesses in TechCenter. This demand curve is
shown in the following slide. Marvel’s costs are constant
and equal to $30 per office cleaning (MC=AC=$30).
The owner of Marvel Cleaning Service is considering three
types of pricing: (1) Uniform Pricing, (2) First-degree Price
Discrimination, and (3) Block Pricing with three pricing
blocks.
 Each one of the businesses enjoys $1,250 of
UNIFORM CONSUMER SURPLUS under uniform pricing.

PRICING MARVEL will charge $55 for an office

cleaning and will face a quantity
TECHNIQUE CS
= ½ $(80 – 55) 100
demanded from each of the 25
identical firms of 100 cleanings per
= $ 1,250 year.
Refer to Student workbook, 55
Homework exercise 1, pp. 319 PPROFIT MARVEL’S TOTAL PPROFIT
of each firm of 25-equal size firms
Marvel believes it faces an = (P – AC) Q* = $ 2,500 * 25
identical demand by each = $(55 – 30) 100 = $ 62,500
one of the 25 businesses in = $ 2,500
TechCenter. This demand
curve is shown on the right.
Marvel’s costs are constant
and equal to $30 per office
cleaning (LMC=LAC=$30).

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FIRST-DEGREE
(PERFECT) PRICE
DISCRIMINATION
Refer to Student workbook,
Homework exercise 1, pp. 319
Marvel believes it faces an
identical demand by each
one of the 25 businesses in
TechCenter. This demand
curve is shown on the right.
Marvel’s costs are constant
and equal to $30 per office
cleaning (LMC=LAC=$30).
For each one of the Under perfect price
businesses, he captures discrimination, MARVEL
$5,000 of CONSUMER
SURPLUS under Perfect
will be hired to clean
each office 200 times
Price Discrimination. per year
TOTAL PROFIT of each firm
MARVEL will earn TOTAL
= dotted shaded area ANNUAL PPROFIT
= $(80 – 30) 200 * ½ of 25-equal size firms
= $ 5,000 = $ 5,000 * 25
= $ 125,000
CONSUMER SURPLUS ??
TOTAL REVENUE
from each firm
= All Shaded Areas
= $(30 + 80) 200 * ½
= $ 11,000
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BLOCK
PRICING
TECHNIQUE
Refer to Student workbook,
Homework exercise 1, pp. 319
Under this three block pricing
plan, each of the businesses
in TechCenter will buy 160 $4,800
cleanings per year.
TOTAL EXPENDITURE by each
business is $ 8,000
MARVEL will earn TOTAL
ANNUAL PPROFIT of $80,000
= [ TE – (AC*Q) ] * 25
= [$8,000 – $(160 * 30)] * 25
= $80,000
If Marvel employs block pricing by choosing
three pricing blocks i.e. $60, $40, and $20, the
total expenditure by each business can be
expressed as follows:
TE (q) = $0 + $60q for q80 (Block 1)
TE (q) = $4,800 + $40(q – 80) for q160 (Block 2)
TE (q) = $8,000 + $20(q – 160) for q240 (Block 3)
DECISION MAKING:
If P > LMC, then MARVEL will sell more,
If P < LMC, then MARVEL will sell less.
$3,200
TOTAL COST
= AC *Q
= $4,800
80 160 240
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 FIRST-DEGREE (PERFECT) PRICE DISCRIMINATION

DIFFERENT PRICING
TECHNIQUES

UNIFORM PRICING TECHNIQUE

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PERFECT vs DECLINING BLOCK PRICE DISCRIMINATION
Refer to Thomas & Maurice textbook, Applied problem 5, pp.619.
“Declining block pricing is a crude form of perfect price
discrimination.”
In what sense is this statement correct? In what important way is it wrong?
Under PERFECT PRICE When multiple units are sold for the same price within
DISCRIMINATION, the pricing blocks, uniform pricing is essentially being
$ blue shaded area is the practiced in each declining block. Thus, declining block
amount of profit earned pricing is a “crude” form of perfect price discrimination
P3 by the discriminating First-degree Price Discrimination
firm, which allows the ▪ requires precise information about every
P2 firm to capture all one of the buyer’s demand for the good,
Consumer Surplus. ▪ the seller must negotiate a different price
P4 for every unit sold to every buyer
P1 MC = AC
Second-degree (Declining Block) PD
▪ requires less information about every one
of the buyer’s demand for the good,
Demand = MR ▪ consumer can select the average price
Q (s)he is willing to pay based on the
Q3 Q2 Q4 Q1 amount of goods purchased.
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THIRD-DEGREE (PERFECT) PRICE DISCRIMINATION
Refer to Thomas & Maurice textbook, Applied problem 6, pp.619.
The Financial Herald, a weekly newspaper specializing in corporate financial news,
is purchased by both businessmen and students. A marketing research firm has
estimated the two linear demand and marginal revenue functions shown in the
diagram next slide. 𝑴𝑹𝑩 is the estimated marginal revenue for the business
readers, and 𝑴𝑹𝑺 is the estimated marginal revenue for the student readers. The
production department at The Financial Herald estimates a linear marginal cost
function for newspaper production, which also is graphed in the diagram. All
quantities are in units of 1,000 per week.

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 Uniform Pricing
▪ Set at QU = 40 where MRT = MC. PU = $0.80
THIRD-DEGREE ▪ TR = $32
Price Discriminnation
PRICE ▪ TR = TRB + TRS = $7 + $27 = $34
DISCRIMINATION
Refer to Thomas & Maurice textbook,
Applied problem 6, pp.619.
a. How many copies should 0.90 A D
the Financial Herald print
each weeks? 0.70 C

b. How many copies should be B E DT

sold to business readers?
How many copies should be
sold to students?
MRT
c. What price should business
readers be charged? What
price should students be Qs QB QT
charged?
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 PRICE
DISCRIMINATION
Refer to Thomas & Maurice textbook, Applied problem 1, pp.619.
STIHL, Inc., manufactures gasoline-powered
chain saws for professional, commercial, farm,
and consumer markets. To better serve their
customers, STIHL offers its chain saws in four
different quality lines and associated price
ranges: occasional use, midrange,
professional, and arborist. Under what
circumstances could offering multiple
qualities of a product be price discrimination?
What form of price discrimination might this
represent – first-, second-, or third-degree
price discrimination? Explain why this practice
could increase profit at STIHL. 15
PRICING TECHNIQUE FOR A MULTIPLE-PRODUCT FIRM
Refer to Thomas & Maurice textbook, Applied problem 10, pp.621.
Berkley Golf & Tennis Club offers golf and tennis memberships. Marketing analysis
of the local neighbourhood served by Berkley Golf & Tennis Club shows that there
are two types of families that might join the club:
golf-oriented families, which are primarily interested in golf but enjoy playing some
tennis, and tennis-oriented families, which are primarily interested in tennis but
enjoy playing some golf.
The study further estimates that there are 400 golf-oriented families and 300
tennis-oriented families in the neighbourhood, and estimated demand prices for
golf and tennis membership by family type are given in the following slide.
There is no way to identify family types for pricing purposes, and all costs are fixed
so that maximising total revenue is equivalent to maximising profit.

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PRICING TECHNIQUE FOR A MULTIPLE-PRODUCT FIRM
Refer to Thomas & Maurice textbook, Applied problem 10, pp.621.

Demand Prices for Golf and Tennis Memberships

Type of family Golf Tennis
membership only membership only
Golf-oriented $250 $100
Tennis-oriented $50 $200
There are 400 golf-oriented families and 300 tennis-oriented families in
the neighbourhood.
If Berkley Golf & Tennis Club plans to offer golf and tennis
memberships separately, what prices should be charged for
each kind of membership if Berkley wishes to maximise profit?
How much total revenue can be generated each month under
this pricing plan?
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 PRICING TECHNIQUE FOR A MULTIPLE-PRODUCT FIRM
Refer to Thomas & Maurice textbook, Applied problem 10, pp.621.
Demand Prices for Golf and Tennis Memberships
Type of family
Consider the following OPTIONS:Golf Tennis Golf and Tennis
1. Price each membershipmembership onlydemandmembership
at the highest price, only membership
2. Price each membership at the
Golf-oriented lowest demand price, $100
$250 OR $350
3. Charge a single price for a bundle
Tennis-oriented $50 with both membership.
$200 $250
There are 400 golf-oriented families and 300 tennis-oriented families in the neighbourhood.
Demand Prices for A Golf Membership PG and A Tennis Membership PT
OPTIONS: DG Membership DT Membership Total Revenue
PG = $250, PT = $200 400 300 ($250 x 400) + ($200 x 300) = $160,000
PG = $ 50, PT = $100 700 700 ($50 x 700) + ($100 x 700) = $105,000
PG = $250, PT = $100 400 700 ($250 x 400) + ($100 x 700) = $170,000
PG = $ 50, PT = $200 700 300 ($50 x 700) + ($200 x 300) = $ 95,000
PG & PT = $250 700 $250 x 700 = $175,000
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 COST-PLUS PRICING TECHNIQUE
Refer to Student workbook, Homework exercise 2, pp. 320
Dr. Rogers takes a managerial economics course at Feenix College of International Business Strategy and
learns that cost-plus pricing is the best way to ensure that she earns a “desirable” or “reasonable” level of profit.
She decides that her skills as a pediatric physician should earn 75% as much as the costs of providing health
care services, so she chooses a markup of 75% on her average total costs.
Dr. Rogers, a respected pediatric physician, has a reputation for being one of the best “baby and kid doctors” in
the area. Dr. Rogers enjoys a rather substantial degree of market power in this market. A marketing research
firm has estimated the demand for her work as a linear function of the price she decides to charge:
𝑄 = 600 − 0.5𝑃
where Q is the number of pediatric examinations performed each month, and P is the average price of a
pediatric exam. Her accountant tells her that her average variable costs are constant and equal to $240 per
exam (AVC = MC = $240). Her total fixed cost each month is $36,000 per month (TFC = $36,000).
a. Derive the inverse demand for Dr. Rogers’s pediatric exams.
0.5𝑃 = 600 − 𝑄  𝑃 = 1,200 − 2𝑄
b. Derive the marginal revenue for Dr. Rogers’s pediatric exams.
𝑇𝑅 = 𝑃𝑄 = 1,200𝑄 − 2𝑄2  𝑀𝑅 = ∆𝑇𝑅Τ∆𝑄  𝑀𝑅 = 1,200 − 4𝑄
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 COST-PLUS PRICING TECHNIQUE
Refer to Student workbook, Homework exercise 2, pp. 320
Currently Dr. Rogers has a full schedule of patients and enjoys a waiting list each month of about 25
patients who cannot get in to see her. She plans her work schedule to work 20 days per month and to
see 20 patients per work day, which allows her to see 400 patients per month. Currently, she charges
a price (on average) of $350 per patient.
c. Explain why Dr. Rogers currently experiences a waiting list of 25 patients each month.
Given that 𝑄 = 600 − 0.5𝑃.
If 𝑃 = $350, 𝑄 = 600 − 0.5(350) = 425.
This shows that, at 𝑃 = $350, 𝑄𝐷 = 425 > 𝑄 𝑆 = 400, an excess demand of 25.
d. Currently, Dr. Rogers’s costs to service 400 patients per month are:
AVC = $240
AFC = TFC/Q = $36,000/ 400 = $90 Her accountant tells her that her average variable costs are
constant and equal to $240 per exam (AVC = MC = $240). Her
ATC = AVC + AFC = $330
total fixed cost each month is $36,000 per month (TFC = $36,000).
TOTAL PROFIT = (P – AC)Q
TOTAL PROFIT = $(350 – 330)* 400 = $8,000.
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 COST-PLUS PRICING TECHNIQUE
Refer to Student workbook, Homework exercise 2, pp. 320
e. As previously mentioned, Dr. Rogers decides to begin setting her price using a 75
percent markup (m) on her current average total costs (use ATC from part d):
𝑃 = (1 + m) ATC If 𝑄𝑒 = 400, Π = 𝑃 − 𝐴𝑉𝐶 𝑄𝑒 − 𝑇𝐹𝐶
𝑃 = 1.75 * $330 = $577.50 Π = $ 577.50 − 240 400 − $36,000 = $99,000.

f. The doctor computes her expected profit from her decision to begin implementing cost-
plus pricing by using the cost-plus price (computed in part e above), and she (incorrectly)
believes she will continue to see 400 patients each month after implementing the cost-
plus price. By treating 400 patients, she predicts her profit will be $_____________
99,000 per
month. Her actual profit when she implements the price in part e will be
$_____________,
68,962.50 which is less than the amount she expects. Explain why.
At 𝑃 = $577.5, 𝑄 = 600 − 0.5 $577.50 = 311.
If 𝑄 =311, Π = 𝑃 − 𝐴𝑉𝐶 𝑄 − 𝑇𝐹𝐶
Π = $ 577.50 − 240 311 − $36,000 = $68,962.50.
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 COST-PLUS PRICING TECHNIQUE
Refer to Student workbook, Homework exercise 2, pp. 320
g. Dr. Rogers, while happy that cost-plus pricing has improved her profits, is troubled
by her profit shortfall. She applies the MR = MC rule to find her profit-maximising
price, number of patients, and profit.
𝑀𝑅 = 1,200 − 4𝑄 ∗ = 𝑀𝐶 = 240, 𝑄 ∗ = 240 and TVC=AVC*q =240.q
𝑃∗ = 1,200 − 2𝑄 ∗ = 1200 − 2 240 = 720 MC = Chg TC/ Chg q = 240
Π = $ 720 − 240 240 − $36,000 = $79,200
h. Explain why her implementation of cost-plus pricing in part e failed to maximise
her profit.
At Cost-plus pricing, 𝑃= (1 + m)ATC,
(1) it fails to incorporate information about demand and marginal revenue,
and (2) it utilises average, not marginal, cost to compute price.

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 SUMMARY
1. Uniform (or Standard) Pricing technique is utilised by a price-making firm to
maximise its profit via charging the same price for the same product.
2. There are different forms of Price Discrimination – First-, Second- or Third-
degree PD, which is an alternative to Uniform pricing technique and is more
profitable than Uniform Pricing technique, but limits to the three conditions for
implementing PD.
3. For a multiple product firm, it can bundle multiple products by charging a single
price, making it more profitable than charging individual prices for multiple
products which is subject to two conditions: (1) consumers have different
demand prices for each product in the bundle and (2) the demand prices for
the multiple products must be negatively correlated across consumer types.
4. Cost-plus pricing strategy is a conventional pricing method which does not lead
to profit-maximisation as this technique does not incorporate market Demand
condition and is determined based on AC instead of MC.
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TUTORIAL TEN

APPLIED PROBLEM 7

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