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pricing and product differentiation
Typology: Lecture notes
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Lecture 3 MANAGERIAL AND DECISION ECONOMICS PRICING AND PRODUCT DIFFERENTIATION COST PLUS PRICING : price is determined by adding a percentage markup to average variable cost.
Under cost plus pricing firms calculate/ estimate AVC [Average Variable Cost; so we’re talking about short run] and then add a mark up to determine price.
The profit margin tends to be higher when demand conditions are strong, and lower when demand is weak.
We assumed so far: firm sets a uniform price which is the same for all consumers. However, a firm that enjoys some market power might consider adopting a more complex pricing policy. The policy of selling different units of output at different prices is known as price discrimination. A firm to decide to choose a price discrimination, must have two necessary conditions: 1)Firm must possess some degree of market power 2)The market must be divisible into submarkets with different demand conditions. These must be separate through time or space so that secondary market or resale between consumers won’t be possible. Price discrimination is divided in three degree:
You discrimination people in base of the price that they can or want to spend.
“Market” in previous slide shows the market demand function (sum of the two submarkets) and the profit maximising output and price when the monopolist charges a uniform price to all consumers. In the case where there are two submarkets, one price will always be higher and the other price lower than the uniform monopoly price that would exist in the non-discriminating case. PRODUCT ANALYSIS: According to neo - classical analysis, consumers will choose different quantities of different products on the basis of their budget, prices and preferences. I. LANCASTER’S CHARACTERISTICS MODEL Lancaster’s (1966) product characteristics model assumes that consumers derive utility from the characteristics or attributes embodied in goods, as opposed to the goods themselves. Goods are viewed as bundles of characteristics. Differentiated goods are goods that contain the same characteristics in different proportions. A consumer seeks to buy goods with the most desirable set of characteristics according to their income and the price of characteristics. Model Assumptions:
, , , and are affordable units of brands A, B, C, and D that can be purchased using a certain budget. is how much of brand C can be purchased when its price increases. Note that can also be attained using a linear combination of and. [If C1 became more expensive, it will called C2. But C can be mixed from B1 and D1, so it has no much value and consequently it makes no sense to buy it. If brand C2 decide to grow up the price again, it becomes C3, but its value will be lower than the mix choice of C2, so the product will have difficulties to be sold].
Each firm chooses location so as to maximise its own profit Each firm’s profit is a linear function of the number of consumers it serves
- (^) Where should the firms locate? If Firm A locates at 0.25 and Firm B locates at 0.75, each serves half of the market However, this is not an equilibrium… A stable equilibrium is found where both firms locate in the centre of town In terms of characteristic space, brands can have similar or identical characteristics Is this applicable to real life? - ‘Districts’: petrol stations, charity shops, fast food restaurants - Politics