Professional Documents
Culture Documents
Competitive Pricing
Techniques
When making pricing decisions, you need to be aware of what your market
structure is
Market Structure Spectrum
Perfect Competition
Monopoly
Cumulative Market
Share
100
A
C
80
40
20
0
01
10
20
# of
Firms
A
C
80
B
40
20
0
01
10
20
# of
Firms
Year
CR50
CR100
CR200
1947
17
23
30
1958
23
30
38
1967
25
33
42
1977
24
33
44
1987
25
33
43
1992
24
32
42
1997
24
32
40
HHI s
i 1
2
i
Rank
Market Share
25
625
25
625
25
625
25
25
25
25
25
HHI = 2,000
Cumulative Market
Share
100
A
HHI = 500
80
B
HHI = 1,000
40
20
0
01
10
20
Cumulative Market
Share
100
80
HHI = 500
HHI = 555
40
B
20
0
01
10
20
CR(4)
HHI
Breakfast Cereals
83
2446
Automobiles
80
2862
Aircraft
80
2562
Telephone Equipment
55
1061
Womens Footwear
50
795
Soft Drinks
47
800
464
Pharmaceuticals
32
446
Petroleum Refineries
28
422
Textile Mills
13
94
Market
Dollars
Dollars
Supply
MC
MR
1.44*
$1.44*
Demand
400
400,000*
In a monopolized market, the single firm in the market faces the industry
demand curve
Individual
Market
Dollars
Dollars
MC
1.44*
$1.44*
Demand
Demand
400,000
400,000*
PQ TC
Total Revenues
equal price times
quantity
PQ TC
How do my profits
change if I
increase my sales
by 1?
How do my
revenues change if
I increase my sales
by 1? (Marginal
Revenues)
How do my costs
change if I
increase my sales
by 1? (Marginal
Costs)
In a world where firms have market power, they control their level of sales by setting their price.
Suppose that you have the following demand curve (A relationship between price and quantity):
Q 100 2 P
Your listed price
Total
Sales
P
For example: If you were to set a
price of $20, you can expect 60
sales
P $20
Q 100 2 20 60
D
Q 60
We could also talk about inverse demand (a relationship between quantity and price):
Q 100 2 P
P 50 .5Q
A price
that will hit
that target
P
For example: If you wanted to
make 40 sales, you could set a $30
price
40 100 2 P
60 2 P
P $30
P 30
D
Q 40
Either way, if we know price and total sales, we can calculate revenues
P 50 .5Q
P
Total Revenues = Price*Quantity
P $30
Total Revenues
=($30)(40)
= $1200
Q 40
Q
Can we increase revenues past
$1200 and, if so, how?
Either way, if we know price and total sales, we can calculate revenues
P 50 .5Q
P
Total Revenues =($35)(30) = $1050
P $35
Total Revenues =($25)(50) = $1250
P $30
P $25
D
Q 30 Q 40 Q 50
Q
Turns out lowering price was the right
thing to do to raise revenues.
p
Total Revenues = PQ
Q
Suppose that you want to increase your sales.
What do you need to do?
Your demand curve will tell you how much you need to lower your price to reach
one more customer
This area represents the revenues
that you lose because you have to
lower your price to existing customers
Q
Q
Your demand curve will tell you how much you need to lower your price to reach
one more customer
P 50 .5Q
p $30
p $29.50
($.50)(40) =$20
D
Q 40
Q 41
Pric
e
2.75 2.50
*100 10%
2.50
%QD 20
D
2
% P
10
$2.7
5
$2.5
0
D I $50,000
4
45
*100 20%
5
Quantit
y
D .61
$35
Q 100 2 P
P
$35
30
$34
32
$20
60
$19
62
$10
80
% Change
in Q
%
Change
in P
Elastici
ty
6.7
-2.9
-2.3
3.3
-5
-.61
$20
D
0
-1
-2
$9
82
2.5
-10
-.255
-3
-4
-5
-6
-7
-8
-9
-10
30
60
Quantit
80 y
P 50 .5Q
P
%P 1.7
% Q
2.5
1.47
% P 1.7
P $30
P $29.50
D
Q 40 Q 41
%Q 2.5
P 50 .5Q
TR PQ
P
Total Revenues =($30)
(40) = $1200
1.47
P $30
P $29.50
D
Q 40 Q 41
% Change in revenues = .
80%
TR PQ
%TR % P %Q
.80%
-1.70%
% Q
2.5
1.47
% P 1.7
1.47
%P 1.7
P $30
P $29.50
D
Q 40 Q 41
%Q 2.5
% Change in revenues = .
80%
2.5%
TR PQ
%TR % P %Q
3.75%
5.00%
% Q 1.25
.25
% P
5.0
% P 5
P $10.50
P $10.00
.25
D
Q 79 Q 80
% Q 1.25
-1.25%
Total Revenues
Elasticity
1400
1200
-1
-2
1000
-3
800
-4
600
-5
-6
400
Elasticity is less
than -1: raise price
Elasticity is greater
than -1: lower price
-7
200
-8
-9
-10
Max Revenues
Quantity = 50
Price =$25
Revenues = $1,250
Quantity = 50
Price =$25
Elasticity = -1
Because you must lower your price to existing customers to attract new
customers, marginal revenue will always be less than price
Q = 40
P = $30
Revenues = ($30)(40) = $1200
60
Q = 41
P = $29.50
Revenues = ($29.50)(41) = $1209.50
40
P = $30
20
MR = $9.50
0
-20
-40
MR
-60
Note that because we have ignored the cost side, we are assuming marginal
costs are equal to zero!
1400
60
Revenues = $1250
1200
40
1000
P = $25
20
P
800
MR = MC = $0
600
-20
400
-40
200
MR
-60
Now, lets bring in the cost side. For simplicity, lets assume that you face a
constant marginal cost equal to $20 per unit.
Quanti
ty
Price
Total
Reven
ue
Margi
nal
Reven
ue
Total
Cost
Margi
nal
Cost
Profit
$49.50
$49.50
$49.50
$20
$20
$29.50
$49
$98
$48.50
$40
$20
$58
$48.50
$145.5
0
$47.50
$60
$20
$85.50
$48
$192
$46.50
$80
$20
$112
$47.50
$237.5
0
$45.50
$100
$20
$137.5
0
$47
$282
$44.50
$120
$20
$162
$46.50
$325.5
0
$43.50
$140
$20
29
$35.50
$1029.
50
$21.50
$580
$20
$449.5
0
30
$35
$1050
$20.50
$600
$20
$450
31
$34.50
$1069.
50
$19.50
$620
$20
$449.5
0
Continuing on
$185.5
0
down
A profit maximizing price sets marginal revenue equal to marginal cost. Marginal
revenue is the change in total revenue (i.e. the slope)
1500
Slope = 20
1000
500
Profits = $450
-500
Total Revenue
Profit
Total Cost
Price = $35
Quantity = 30
Elasticity = -2.36
60
50
P MC $35 $20
.42
P
$35
40
P = $35
30
20
Profit = ($35-$20)*30
= $450
1
1
.42
2.36
10
0
-10
-20
-30
Price
Marginal Revenue
Marginal Cost
LI
Communication
.972
.930
.921
Food Products
.880
General Manufacturing
.777
Furniture
.731
Tobacco
.638
Apparel
.444
Motor Vehicles
.433
Machinery
.300
Suppose that we
assumed the
automobile
industry were
monopolized
P MC
.433
P
1
2 .3
.433
p
Loss from charging
existing customers a
lower price
Dollars
$120
$80
Alumni
Faculty
Students
$40
40,000
70,000
80,000
Dollars
$120
$80
Alumni
Price
Quantity
Total
Revenue
Total Cost
Profit
$120
40,000
$4.8M
$800,000
$4.0M
$80
70,000
$5.6M
$1.4M
$4.2M
$40
80,000
$3.2M
$1.6M
$1.6M
Faculty
Students
$40
$20
0
MC
40,000
70,000
80,000
Dollars
$120
$80
Alumni
Price
Quantit
y
Total
Revenu
e
Total
Cost
Profit
$120
40,000
$4.8M
$400,00
0
$4.4M
$80
30,000
$2.4M
$300,00
0
$2.1M
$40
10,000
$400,00
0
$200,00
0
$200,00
0
Total
80,000
$7.6M
$900,00
0
$6.7M
Faculty
Students
$40
$20
0
MC
40,000
70,000
80,000
Example: DVD codes are a digital rights management technique that allows film
distributors to control content, release date, and price according to region.
Dollars
$15
General
Public
$8
Pricing Schedule
Regular Price: $15
Senior Citizens: $8
0
200
300
Ticket
Price
Popcorn
Price
Total
Option #1
$14
$1
$15
Option #2
$8
$7
$15
Option #3
$2
$13
$15
Dollars
$15
Avid
Moviegoer
Occasional
Moviegoer
$8
200
Q 100 100 P
Dollars
.50
Quantity (rides)
$1
$.99
$.98
$0
100
Demand
50
Q 100 100 P
Dollars
.51
Profit = $24.01
MC
Demand
.02
0
49
MR
Price
(per
ride)
Quanti
ty
(rides)
Total
Reven
ues
Margin
al
Reven
ues
Margin
al Cost
$1
$0
$.99
$.99
$.99
$.02
$.98
$1.96
$.97
$.02
$.52
48
$24.96
$.05
$.02
$.51
49
$24.99
$.03
$.02
$.50
50
$25
$.01
$.02
If all Disney does is charge a price per ride, they are leaving
some money on the table
Q 100 100 P
Dollars
$1
CS = (1/2)($1-.51)*49 = $12.00
.51
Profit = $24.01
MC
Demand
.02
0
49
MR
Like the movie theatre, Disney has two prices to play with. We have a
price per ride as well as an entry fee. For any price per ride, we can set
the entry fee equal to the consumer surplus generated.
Q 100 100 P
Dollars
Fee = (1/2)($1-P)*Q
$1
$P
Profit = (P-.02)*Q
Price
(per
ride)
Quantity
(rides)
Ride
Revenu
e
Fee
Revenu
e
Total
Revenu
es
Margin
al
Revenu
es
Margin
al Cost
$1
$0
$0
$0
---
---
$.99
$.99
$.005
$.995
$.995
$.02
$.98
$1.96
$.02
$1.98
$.985
$.02
$.03
97
$2.91
$47.0
5
$49.9
6
$.03
$.02
$.0
2
98
$1.96
$48.0
2
$49.9
8
$.02
$.02
$.01
99
$.99
$49
$49.9
9
$.01
$.02
MC
Demand
.02
0
The optimal pricing scheme here is to set a price per ride equal
to marginal cost. We then set the entry fee equal to the
consumer surplus generated.
Q 100 100 P
Pricing Schedule
Entry Fee: $48.02
Price Per Ride: $.02
Dollars
Fee = (1/2)($1-.02)*98 = $48.02
$1
Or, we could
combine the two
.02
MC
Demand
98
Now, suppose that we introduced two different clientele. Say, senior citizens and
Non-seniors. We could discriminate based on price per ride (assume there is one
of each type)
Non-Seniors
Seniors
Q 100 100 P
Q 80 100 P
Dollars
Dollars
$1
$.80
.51
.41
Profit = $24.01
Profit = $15.21
MC
Demand
.02
0
49
MC
Demand
.02
0
39
MR
MR
Alternatively, you set the cost of the rides at their marginal cost ($.02) for
everybody and discriminate on the entry fee.
P = $.02/Ride
Dollars
$1
Entry Fee =
Seniors
Q 80 100 P
MC
Demand
$30.42 Old
Non-Seniors
Q 100 100 P
.02
$48.02 Young
98
$.80
.02
78
MC
Demand
Dollars
$1
Non-Seniors
Q 100 100 P
Seniors
Q 80 100 P
.02
MC
Demand
98
$.80
.02
MC
Demand
78
Suppose that you couldnt distinguish High value customers from low value
customers: Would this work?
Dollars
$1
Q 80 100 P
Q 100 100 P
.02
MC
Demand
98
Pricing Schedule=
$.80
.02
78
MC
Demand
We know that is the high value consumer buys 98 ticket package, all her surplus
is extracted by the amusement park. How about if she buys the 78 Ride
package?
$100
$15.60
$30.42
$22
$17.16
Q 100 100 P
78
You need to set a price for the 98 ride package that is incentive compatible. That
is, you need to set a price that the high value customer will self select. (i.e., a
package that generates $15.60 of surplus)
p
Total Willingness = $49.98
$1.00
= $34.38
$48.02
$.02
$1.96
98
Bundling
Suppose that you are selling two products. Marginal costs for these products
are $100 (Product 1) and $150 (Product 2). You have 4 potential consumers
that will either buy one unit or none of each product (they buy if the price is
below their reservation value)
Sum
$50
$450
$500
$250
$275
$525
$300
$220
$520
$450
$50
$500
If you sold each of these products separately, you would choose prices
as follows
TR
Profit
TR
Profit
$450
$450
$350
$450
$450
$300
$300
$600
$400
$275
$550
$250
$250
$750
$450
$220
$660
$210
$50
$200
-$200
$50
$200
-$400
Sum
$50
$450
$500
$250
$275
$525
$300
$220
$520
$450
$50
$500
$50
$450
$500
$250
$275
$525
$300
$220
$520
$450
$50
$500
Price 1 = $250
Price 2 = $450
Bundle = $500
Profit = $850
or $800
$50
$450
$500
$250
$275
$525
$300
$220
$520
$450
$50
$500
Price 1 = $450
Price 2 = $450
Bundle = $520
Profit = $1,190
$300
$200
$500
$300
$200
$500
$300
$200
$500
$300
$200
$500
Suppose that you sell laser printers. To create printed pages, you need both a printer
and an ink cartridge. For now, assume that the toner cartridges are sold in a
competitive market and sell for $2 each. An ink cartridge is good for 1,000 printed
pages.
Q 16 P
Dollars
Quantity of
printed pages
(000s)
Toner cartridge
price
$2
Demand
14
Now, suppose that you design a printer that requires a special cartridge that
only you produce. What would you do if you could choose a printer price
and a cartridge price?
Q 16 P
Dollars
$16
Quantity of
printed pages
(000s)
Toner cartridge
price
$9
MC
$2
Demand
7
MR
TR
TC
MR
MC
Pro
fit
$15
$15
$2
$15
$2
$13
$14
$28
$4
$13
$2
$24
$13
$39
$6
$11
$2
$33
$12
$48
$8
$9
$2
$40
$11
$55
$10
$7
$2
$45
$10
$60
$12
$5
$2
$48
$9
$63
$14
$3
$2
$49
$8
$64
$16
$1
$2
$48
Q 16 P
Dollars
$16
Quantity of
printed pages
(000s)
MC
$2
TR
CS
Tota
l
TC
MR
MC
Pro
fit
$15
$15
$.5
$15.
5
$2
$15.
5
$2
$13.5
$14
$28
$2
$30
$4
$14.
5
$2
$26
$13
$39
$4.5
$43.
5
$6
$13.
5
$2
$37.5
$12
$48
$8
$56
$8
$12.
5
$2
$48
$11
$55
$12.5
$67.
5
$1
0
$11.
5
$2
$57.5
13
$3
$39
$84.5
$123
.5
$2
6
$3.5
$2
$97.5
Demand
14
MR
Toner cartridge
price
Now, suppose that you have two customers. Call them high value and low value.
Suppose that you can easily identify them and prevent resale. We could
discriminate on both the printer price and the cartridge price.
Q 12 P
Q 16 P
Dollars
Dollars
$16
$9
$12
$7
MC
$2
MC
$2
Demand
Demand
0
MR
5
MR
Dollars
Q 12 P
Q 16 P
Dollars
$16
MC
$2
$12
MC
$2
Demand
14
Demand
Profit = $98
10
Profit $50
Suppose that you couldnt explicitly price discriminate. Lets say that you know
you have a high value and low value demander, but you dont know who is who.
Lets first try and do this like the amusement park
Dollars
Q 12 P
Q 16 P
Dollars
$16
MC
$2
$12
MC
$2
Demand
14
Demand
10
Suppose that you couldnt explicitly price discriminate. Lets say that you know
you have a high value and low value demander, but you dont know who is who.
Lets first try and do this like the amusement park
Q 16 P
Dollars
$16
$6
$60
Demand
10
Total Willingness to Pay = $110
- 10 Cartridge Package = $70
Consumer Surplus = $40
Lets try a different strategy. Suppose that you charge a markup on the cartridges
and then charge a common price for the printer to each. We would set the price
of the printer equal to the consumer surplus of the lower value demander of insure
that both groups buy the printer.
Q 12 P
Example:
Cartridge Price: $3
Consumer Surplus = *($12 - $3)(9) = $40.50
Dollars
CS = *($12 - $P)(12-P)
$12
$P
$60
Demand
12-P
P Q1 Q2
Q 16 P
.512 P Q2
Q 12 P
$2 Q1 Q2
2 * CS
Price
Quantity
1
Quanti
ty 2
Total
Reven
ue
Consumer
Surplus
Printer
Revenue
Total
Revenue
Total
Cost
Profit
$0
16
12
$0
$72
$144
$144
$56
$88
$.25
15.75
11.75
$6.875
$69.03
$138.06
$144.93
$55
$89.93
$.50
15.5
11.5
$13.50
$66.135
$132.25
$145.75
$54
$91.75
$3
13
$66
$40.5
$81
$147
$44
$103
$4
12
$80
$32
$64
$144
$40
$104
$4.25
11.75
7.75
$82.87
5
$30.03
$60.06
$142.93
$39
$103.93
Lets try a different strategy. Suppose that you charge a market on the cartridges
and then charge a common price for the printer to each. We would set the price
of the printer equal to the consumer surplus of the lower value demander of insure
that both groups buy the printer.
Q 12 P
Best Choice:
Dollars
$12
$4
$60
Demand
Q 12 PH PB
Price of a Hot Dog
Q 12 PH $2 10 P
You
charge $5
Quantity
Price
Total
Revenue
Marginal
Revenue
$9
$9
$9
$8
$16
$7
$7
$21
$5
$6
$24
$3
$5
$25
$1
$4
$24
-$1
Q 12 PB $5 7 P
Bun Guy
charge $4
Quantity
Price
Total
Revenue
Marginal
Revenue
$6
$6
$6
$5
$10
$4
$4
$12
$2
$3
$12
$0
$2
$10
-$2
$1
$6
-$4
But, if the bun guy is charging $4, you need to react to that
Q 12 PB $4 8 P
You
charge $4
Quantity
Price
Total
Revenue
Marginal
Revenue
$7
$7
$7
$6
$12
$5
$5
$15
$3
$4
$16
$1
$3
$15
-$1
$2
$12
-$3
Q 12 PB PH 8 P
You
charge $6
for hot
dog/bun
Quantity
Combined
Price
Total
Revenue
Marginal
Revenue
$11
$11
$11
$10
$20
$9
$9
$27
$7
$8
$32
$5
$7
$35
-$3
$6
$36
-$1
$5
$35
-$1
$4
$32
-$3
$3
$27
-$5
Q 12 PB PH
PH $4
PB $4
Consumer Pays $8 for a
hot dog/bun pair
PH PB $6