Managerial EconomicsJack Wu

Pricing Policyuniform pricingcomplete price discriminationdirect segment discriminationindirect segment discriminationbundling

Northwest AirlinesMinneapolis-New York

Business class $ 1711

Unrestricted economy

$ 1267

Advance purchase, with penalties

$ 765

Advance purchase, for senior

$ 692

Asian Wall Street Journal

Price for annual subscription

Print: Hong Kong $294

Print: Singapore $173

Print: Tokyo $871

Interactive: Worldwide $59

0

30

55

80

2500 5000

marginal revenue

marginal cost

demand

Quantity (Units a year)

Pri

ce (

Thousa

nd Y

en p

er

unit

)

Uniform Pricing

Uniform Pricing: Profit MaximumMR = MCEquivalently, set the incremental margin

percentage equal to the inverse of absolute value of price elasticity of demand,

(price - MC) / price = -1/e

Price Elasticityalways set price so that demand is elasticif demand more elastic, then lower

incremental margin percentage (IM%) e = -2 IM% = 1/2

e = -1.5 IM% = 2/3

Pricing Private-Label Cola Suppose that WalMart learns that demand

for private-label cola is less elastic than the demand for Coca Cola. Should WalMart set a higher price for private-label cola?

Uniform Pricing: Shortcomingsleaves buyers with

a lot of surplusdoes not sell to

every potential buyer

Complete Price Discriminationprice each unit at buyer’s benefit and sell

quantity where MB = MC � maximum profit -- theoretical ideal� different from MR = MC

implementation: must know entire marginal benefit and marginal cost curves

Complete Price Discrimination: Practice

bargainingauctions

Direct Segment Discrimination, Iprice by segmentimplementation

� fixed identifiable characteristic --- basic for segmentation

� no re-sale

Direct Segment Discrimination, IIsimple case: uniform price within each segment

� within each segment IM% = -1/e� for segment with more elastic

demand, then lower incremental margin percentage (IM%)

0

30

55

80

25003000

Quantity (Units a year)

Pri

ce (

Thousa

nd Y

en p

er

unit

)

(a) Men’s demand

0

30

50

Quantity (Units a year)

Pri

ce (

Thousa

nd Y

en p

er

unit

)

(b) Women’s demand

marginal revenue

demand

40

1000

marginal revenue

demand

marginalcost

Direct Segment Discrimination, III

marg.cost

NYNEX Telephone ServiceNew York Cityresidential -- $16/month business -- $23/monthHow is discrimination possible?

Indirect Segment Discriminationstructure choice to earn different incremental

margins from each segmentimplementation

seller controls some variable to which segments are differentially sensitive

buyers cannot circumvent the variable

Traveler

Segment

Unrestricted Travel ($)

Restricted Travel ($)

Maria Business 1000 200 Tom Business 900 180 Robin Vacation 500 400 Leslie Vacation 280 224

Air Travel: Benefits

Product

Fare ($)

Sales

Total Rev. ($)

Total Cost ($)

Profit ($)

Unrestricted

900 2 1800 400 1400

Restricted 399 1 399 200 199

*MC=200

Air Travel: Indirect Segment Discrimination

Chinese Embassy: Visa Fees

Application period

1 day 3 days 7 days

Single entry $75 $60 $25

Double entry $85 $70 $35

Profitability Policy Information Requirement

Highest Complete price discrimination

Highest

Direct segment discrimination

Indirect segment discrimination

Lowest Uniform pricing Lowest

Pricing Policies: Ranking

Bundlingstrategy

pure bundlingmixed bundling

Cable Television: Benefits

“if every segment … was wild about one thing and hated the rest, they have done their job” (Economist) Segment Education

channel Music channel

Conservatives $20 $ 2

Middle of road $11 $11

Pure or Mixed BundlingWhat is the profit-maximizing pricing policy if marginal cost per channel = 0 marginal cost per channel = $5

Pure or Mixed BundlingGenerally, if item is costless, no loss from giving it to every

consumer --> pure bundling; if item is costly, then should avoid providing it to

low-benefit users --> use mixed bundling to screen out low-benefit users.

Mixed bundling is form of indirect segment discrimination

structured choice between bundle and separates