Getting into Walt Disney World: One Price Does Not Fit All

© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.

Fernando & Yvonn Quijano

Prepared by:

Chapter

15

Pricing Strategy

2 of 24© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.

Getting into Walt Disney World: One Price Does Not Fit All

15.1 Define the law of one price and explain the role of arbitrage.

15.2 Explain how a firm can increase its profits through price discrimination.

15.3 Explain how some firms increase their profits through the use of odd pricing, cost-plus pricing, and two-part tariffs.

Learning Objectives

In this chapter, we will study some common pricing strategies, and we will see how Disney and other firms use these strategies to increase their profits.

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© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 3 of 24

Transactions costs The costs in time and other resources that parties incur in the process of agreeing to and carrying out an exchange of goods or services.

Pricing Strategy, the Law of One Price, and Arbitrage

Learning Objective 15.1

Arbitrage

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Solved Problem 15-1Is Arbitrage Just a Rip-off?

Learning Objective 15-1

Does eBay serve a useful economic purpose?

Economists would say that it does.

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Pricing Strategy, the Law of One Price, and Arbitrage


Why Don’t All Firms Charge the Same Price?

Table 15-1

Which Internet Bookseller Would You Buy From?

PRODUCT: HARRY POTTER AND THE DEATHLY HALLOWS

COMPANY PRICE

Amazon.com $18.89

BarnesandNoble.com 18.89

WaitForeverForYourOrder.com 17.50

JustStartedinBusinessLastWednesday.com 16.75

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Price discrimination Charging different prices to different customers for the same product when the price differences are not due to differences in cost.

Price Discrimination: Charging Different Prices for the Same Product


Don’t Let This Happen to YOU!Don’t Confuse Price Discrimination with Other Types of Discrimination

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1 A firm must possess market power.

2 Some consumers must have a greater willingness to pay for the product than other consumers, and the firm must be able to know what prices customers are willing to pay.

3 The firm must be able to divide up—or segment—the market for the product so that consumers who buy the product at a low price are not able to resell

it at a high price. In other words, price discrimination will not work if arbitrage is possible.


The Requirements for Successful Price Discrimination

A successful strategy of price discrimination has three requirements:


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The Requirements for Successful Price Discrimination

FIGURE 15-1

Price Discrimination by a Movie Theater


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Solved Problem 15-2How Dell Computer Uses Price Discrimination to Increase Profits

Learning Objective 15-2

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FIGURE 15-2

33 Customers and 27 Different Prices


Airlines: The Kings of Price Discrimination

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How Colleges Use Yield ManagementMaking

the

Connection

Some colleges use yield management techniques to determine financial aid.

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FIGURE 15-3

Perfect Price Discrimination


Perfect Price Discrimination

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FIGURE 15-4

Price Discriminationacross Time


Price Discrimination across Time

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In 1936, Congress passed the Robinson–Patman Act, which outlawed price discrimination that reduced competition, but which also contained language that could be interpreted as making illegal all price discrimination not based on differences in cost.


Can Price Discrimination Be Illegal?

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Many firms use what is called odd pricing—for example, charging $4.95 instead of $5.00, or $199 instead of $200.

Other Pricing Strategies


Odd Pricing: Why Is the Price $2.99 Instead of $3.00?

Do consumers have an illusion that a price of $9.99 is significantly cheaper than $10.00?

There is some evidence that using odd prices makes economic sense.

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1 When marginal cost and average cost are roughly equal

2 When the firm has difficulty estimating its demand curve



Why Do Firms Use Cost-Plus Pricing?

Economists conclude that cost-plus pricing may be the best way to determine the optimal price in two situations:

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Two-part tariff A situation in which consumers pay one price (or tariff) for the right to buy as much of a related good as they want at a second price.


Pricing with Two-Part Tariffs

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FIGURE 15-5

A Two-Part Tariff at Disney World



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Table 15-2

Disney’s Profits per Day from Different Pricing Strategies

MONOPOLY PRICEFOR RIDES

COMPETITIVE PRICE FOR RIDES

PROFITS FROM ADMISSION TICKETS $240,000 $960,000

PROFITS FROM RIDE TICKETS 480,000 0

TOTAL PROFIT 720,000 960,000



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1 Because price equals marginal cost at the level of output supplied, the outcome is economically efficient.

2 All of consumer surplus is transformed into profit.

The rides at Disney World are free—once you have paid to get into the park.



It is important to note the following about the outcome of a firm using an optimal two-part tariff:

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Price discriminationTransactions costsTwo-part tariff

K e y T e r m s

Getting into Walt Disney World: One Price Does Not Fit All

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