Chapter 3

Firm Strategy

A) Pricing Strategy
Different methods of pricing
i) Neoclassical profit maximizing price
  PQ  TC
Problems
• No sufficient info. about demand
• Not fair (may be cost 10 and price 100?)
2) Cost plus Pricing (Mark-up pricing)
• Mark up = profit margin and fixed cost
Price  AVC  %markup
Price  AVC  m( AVC )
Price  AVC (1  m)
• Advantages
• Simple to calculate as it is easy to get cost
• Stable – doesn’t fluctuate with demand
• fair
3) Price Discrimination
• Selling identical goods produced by equal cost at
different prices
Conditions
– Market power
– Different demand for the product
• There are three types of price discrimination:
– First degree price discrimination
(based on MWTP, rich high and poor low price)
– Second degree price discrimination
(based on quantity – cheap if you buy more)
– Third degree price discrimination (di)
(high demand – expensive, low demand cheap)
 Other forms of price discrimination
a) Inter-temporal price discrimination
• Early purchase – expensive, late purchase cheap
b) Brand labels
• The same product produced in different firms
have different prices (Japanese and Chinese)
c) Loyalty discounts
• frequently purchase – discount
d) Stock clearance
• Decrease price until all the inventory is sold
e) Metering
• Tied products (primary low and secondary
high price)
f) Free-on-board pricing
• Covering transportation cost and selling the
product at the same price in different areas
3) Peak-load pricing
• Peak – periods – high price
• off-peak periods – low price
4) Transfer Pricing
5) Price Dispersion
• If price of the same product sold by different
sellers is different then there is weak
competition
B) Product Differentiation Strategy
• Making one’s product different from other
• Types of product differentiation
i) Vertical product differentiation:
• Improvement in quality of the same product
• Samsung Galaxy S20, S20+, and S20 Ultra
ii) Horizontal product differentiation
• Product of different companies
• smartphones like iPhone, Android, Blackberry,
Windows phone, Samsung Galaxy, etc.
• Causes of product differentiation
i. Natural product differentiation:
• Not created intentionally
– Geographic variation (eg. houses)
– New technology
– Brands and trademarks-
– Community or national differences
– Consumer tastes and preferences
– Additional services
– Rate of change of product differentiation
– Factor variations
– Consumer ignorance
ii. Strategic product differentiation
• Intentionally (consciously) created by the
seller
• Some times they consciously strengthen the
natural differentiation
• There is no clear cut boundary between the
two
C) Advertisement Strategy
• Is telling about your product to the actual and
potential customers
• It includes direct mail, in-store promotion,
telemarketing, product placements,
sponsorship and exhibitions.
• Two types of advertisements
– Informative advertising (good for the society)
– Persuasive advertising (not good to the society)
• Why firms Advertise?
– To launch a product or service
– To provide information on price , quality, location
– To increase or protect market share
– To establish a brand’s image or strengthen
consumers’ brand loyalties.
– Change in the marginal cost of advertising (low tax
high ad. )
Advertising and Product Characteristics
• Assessable (Search) goods:
– you can understand the quality of the product before
using
– Les advertised
• Non-assessable (experience) goods:
– You know its quality after using
– Highly advertised
• A credence goods
– You cannot know its quality before or after using it
– To know it you have to be professional
– Highly advertised
• Other way of classifying goods and services
 Convenience goods
– relatively cheap and frequently purchased
– Less advertised
 Shopping goods
– Relatively expensive and purchased infrequently.
– Highly advertised
Advertising is also used as barrier to entry
 The one advertised is more competitive than the other
Advertising helps in information search and
in some extent quality signaling
Is there too much advertising? yes
D) Research and development strategy
• R&D creates new tech. that changes output,
product quality, employment, wages, technique of
doing things etc
• Joseph Schumpeter identifies three stages of R&D
 Invention: Invention is creating something new and
original
 Innovation: Innovation is turning the new idea
(novelty or invention) into a commercial product
 Diffusion: Technological diffusion is the process by
which innovations spread within and across
economies.
• In an other way R&D can be classified into five
i. Basic research: to find new idea (invention)
ii. Applied research: To solve problem at hand

Innovation
iii. Development (making prototype or pilot
application)
iv. Commercial production (mass production)
v. Diffusion (copied by other producers)

• The Gale Creative Destruction: creation of new

technologies destruct the old ones.
• Market structure and R&D
– Perfectly competitive market have incentive but
no means (profit) to invest in R&D
– Pure monopoly has means (profit) but no
incentive
– Oligopoly has both incentive and means
Research and Development Strategies
• an offensive strategy (creating new)
• a defensive strategy (protecting the old)
• an imitative strategy, (copying from others)
• a dependent strategy, (borrows or acquires a
license from others)
• The pace of diffusion
– Effective Communication increases pace
– Management inertia (education and experience)
increases pace
– Protecting an older technology decreases pace
– Employee or trades union resistance: if the
technology affects the employees negatively this
decreases its pace
– Strict Regulation decreases pace
– High risk and low liquidity decreases pace
– Patents decreases pace