Deck 14: Advanced Pricing Techniques

Question 1

STIHL, Inc., manufactures gasoline-powered chain saws for professional, commercial, farm, and consumer markets. To "better serve" their customers, STIHL offers its chain saws in four different quality lines and associated price ranges: occasional use, midrange, professional, and arborist. Under what circumstances could offering multiple qualities of a product be price discrimination? What form of price discrimination might this represent-first-, second-, or third-degree price discrimination? Explain why this practice could increase profit at STIHL.

Answer 1

Price discrimination (Second degree) is important because each product can be used in different ways by different consumers. Price discrimination can be used in situations when firms want to enter in every segment of market as it cannot enter every market at the same price. They have to reframe their price structure based on consumer marginal valuations while entering into respective markets.
This will no doubt improve the profit level of the company as it allows the consumers to choose their desired level of price by choosing a higher or lower quantity of goods. Usually second degree price discrimination occurs in the form of quantity discounts i.e. a lower price at higher quantities. So, consumers are tempted to buy more quantity in order to have to pay lower prices. This helps producers to sell larger quantities, though at a smaller profit margin. However, because of more quantities sold, the overall profit increases.

Question 2

Price discrimination sounds like a socially "bad" thing. Can you think of any reasons why price discrimination could be viewed as a socially "good" thing?

Answer 2

Price discrimination works by charging different prices from different sets of consumers. It helps create distinction in the market by setting different prices for different groups of people. Though it is a profitable act for the monopolists, it is sometimes equally bad for the consumers. For e.g. in cases where producers charge higher prices in neighborhoods where people have lesser alternatives available, price discrimination can prove to be harmful to consumer surplus. Also, charging different prices to people based on ethnicity, gender and skill status also imposes a higher cost on the society at the expense of higher producer profits.

Question 3

In the mid-1990s, long before September 11, 2001, airlines began requiring photo identification to check baggage and board flights, claiming their fervent commitment to secure and safe air travel. Do you think the airlines implemented this policy because they could foresee the coming terrorist threat to aviation? What might be a more plausible explanation for the airlines' early commitment to photo identification?

Answer 3

Airline industry implemented the policy to have photo identification machines to check baggage before boarding a flight is a good step towards safe travelling without any extra costs. This will not only help avoid terror threats but will also help in stopping people from carrying unnecessary things that might prove to be harmful inner side the flight.
Moreover, terrorist attacks can happen anywhere and anytime. Thus, it is always better to take necessary steps to avoid such mishaps.
According to their say, it is better to be safe than sorry!

Question 4

As markets for some products and services experience greater global competition, what is the likely consequence for the incidence of price discrimination? Do you think global competition fosters or impedes price discrimination? Can you give any examples from your own work experience?

Question 5

"Declining block pricing is a crude form of perfect price discrimination." In what sense is this statement correct? In what important way is it wrong?

Question 6

The Financial Herald , a weekly newspaper specializing in corporate financial news, is purchased by both businesspeople and students. A marketing research firm has estimated the two linear demand and marginal revenue functions shown in the following figure. MR B is the estimated marginal revenue for the business readers, and MR S is the estimated marginal revenue for the student readers. The production department at The Financial Herald estimates a linear marginal cost function for newspaper production, which also is graphed in the following figure. All quantities are in units of 1,000 per week.

a. How many total copies should The Financial Herald print each week?
b. How many copies should be sold to business readers? How many copies should be sold to students?
c. What price should business readers be charged? What price should students be charged?

Question 7

EZ Sharp Industries, Inc., manufactures the Keen Edge™ line of diamond-abrasive cutlery sharpeners for home use. EZ Sharp holds a patent on its unique design and can earn substantial economic profit if it prices its Keen Edge™ products wisely. EZ Sharp sells two models of its Keen Edge™ sharpeners: the Classic, which is the entry-level model, and the Professional, which has a sonic sensor that controls the speed of the sharpening wheels. Short-run production of sharpeners is subject to constant costs: AVC = SMC for both models. The constant costs of production at EZ Sharp Industries are estimated to be

where AVC C and SMC C are the constant costs for the Classic model and AVC P and SMC P are the constant costs for the Professional model. Total fixed costs each month are $10,000. The sole owner of EZ Sharp also manages the firm and makes all pricing decisions. The owner-manager believes in assuring himself a 200 percent profit margin by using the cost-plus pricing methodology to set prices for his two product lines. At these prices, EZ Sharp is selling 3,750 units of the Classic model per month and 2,000 units of the Professional model per month.
a. Using the cost-plus technique, compute the prices the owner-manager charges for the Classic and the Professional models, based on his required 200 percent profit margin.
b. How much profit is EZ Sharp earning each month using the cost-plus prices in part a ? The owner-manager is ready to sell the firm, but he knows the value of the firm will increase if he can increase the monthly profit somehow. He decides to hire Andrews Consulting to recommend ways for EZ Sharp to increase its profits. Andrews reports that production is efficient, but pricing can be improved. Andrews argues that the costplus pricing technique is not working well for EZ Sharp and presents a new pricing plan based on optimal pricing techniques (i.e., the MR = MC rule).
To implement the MR = MC methodology, Andrews undertakes a statistical study to estimate the demands for two Keen Edge™ products. The estimated demands are

where Q C and Q P are the monthly quantities demanded of Classic and Professional models, respectively, and P C and P P are the prices of the Classic and Professional models, respectively. Andrews Consulting solved the demand equations simultaneously to get the following inverse demand functions, which is why Anderson gets paid the "big bucks":

c. Find the two marginal revenue functions for the Classic and Professional model sharpeners.
d. Set each marginal revenue function in part c equal to the appropriate cost and solve for the profit-maximizing quantities.
e. Using the results from part d , what prices will Andrews Consulting recommend for each of the models?
f. When the owner-manager sees the prices recommended by Andrews Consulting, he brags about how close his simple cost-plus pricing method had come to their suggested prices. Compute the profit EZ Sharp can earn using the consultants' prices in part d. Is there any reason for the owner-manager to brag about his costplus pricing skills?

Question 8

Although there is relatively little difference in the cost of producing hardcover and paperback books, these books sell for very different prices. Explain this pricing behavior.

Question 9

The Wall Street Journal once reported on dating services, noting that the fees were $300 for men and $250 for women. The owner of the service said that the difference in fees was to compensate for inequalities in pay scales for men and women. Can you suggest any alternative reasons for this difference?

Question 10

Berkley Golf Tennis Club offers golf and tennis memberships. Marketing analysis of the local neighborhood served by Berkley Golf Tennis Club shows that there are two types of families that might join the club: golf-oriented families, which are primarily interested in golf but enjoy playing some tennis, and tennis-oriented families, which are primarily interested in tennis but enjoy playing some golf. The study further estimates that there are 400 golf-oriented families and 300 tennis-oriented families in the neighborhood, and the estimated demand prices for golf and tennis memberships by family type are given below. There is no way to identify family types for pricing purposes, and all costs are fixed so that maximizing total revenue is equivalent to maximizing profit.

a. If Berkley Golf Tennis Club plans to offer golf and tennis memberships separately, what prices should be charged for each kind of membership if Berkley wishes to maximize profit? How much total revenue can be generated each month under this pricing plan?
b. The manager of Berkley Golf Tennis Club has just finished her MBA degree and has an idea that bundling golf and tennis memberships might increase profit for the club. Are the conditions right for bundle pricing to increase profit at Berkley Golf Tennis?
c. What is the optimal price to charge for a golf and tennis (bundled) membership? How much revenue will this produce for Berkley Golf Tennis Club? Is bundling a profitable pricing tactic for the club?

Question 11

Airlines practice price discrimination by charging leisure travelers and business travelers different prices. Different customers pay varying prices for essentially the same coach seat because some passengers qualify for discounts and others do not. Since the discounts are substantial in many cases, the customer who qualifies for a discount pays a significantly lower airfare.
a. Which group of customers tends to pay the higher price: business travelers or leisure travelers?
b. Why would business travelers generally have a different elasticity of demand for air travel than leisure travelers? Is the more elastic market paying the lower or higher price? Is this consistent with profit maximization?
Airlines rely on an assortment of restrictions that travelers must meet to qualify for the discounted fares. In effect, these restrictions roughly sort flyers into business travelers and leisure travelers.
c. Explain how each of the following restrictions sometimes used by airlines tends to separate business and leisure travelers.
(1) Advance purchase requirements, which require payment at least 14 days before departure.
(2) Weekend stay requirements, which require travelers to stay over a Saturday night before returning.
(3) Time-of-day restrictions, which disallow discounts for travel during peak times of the day.
d. In each of these cases, which group of passengers effectively pays a higher price for air travel? Is this consistent with profit maximization?

Question 12

A woman complained to "Dear Abby" that a laundry charged $1.25 each to launder and press her husband's shirts, but for her shirts-the same description, only smaller- the laundry charged $3.50. When asked why, the owner said, "Women's blouses cost more." Abby suggested sending all the shirts in one bundle and enclosing a note saying, "There are no blouses here-these are all shirts."
a. Is the laundry practicing price discrimination, or is there really a $2.25 difference in cost?
b. Assuming the laundry is engaging in price discrimination, why do men pay the lower price and women the higher?
c. Could the laundry continue to separate markets if people followed Abby's advice? What about the policing costs associated with separating the markets?

Question 13

A bar offers female patrons a lower price for a drink than male patrons. The bar will maximize profit by selling a total of 200 drinks (a night). At the current prices, male customers buy 150 drinks, while female customers buy 50 drinks. At this allocation between markets, the marginal revenue from the last drink sold to a male customer is $1.50, while the marginal revenue from the last drink sold to a female customer is $0.50.
a. What should the bar do about its pricing?
b. If the bar sells 151 drinks to males and 49 to females, what will be the increase (decrease) in total revenue?