Pricing Decisions

Question 1

How are Pricing decisions made?

Answer 1

• Based on theories of demand, cost and market structure
• Pricing decisions can be aspirational or strategical

Question 2

What is the definition of a Market?

Answer 2

• Consists of al firms willing to sell to consumers wiling to buy a product at a given price

Question 3

What is competition?

Answer 3

• How readily available substitutes
• Substitutes have similar performance, occurrence, sales in the market, characteristics

Question 4

How can market structures be determined? How does this affect the firms?

Answer 4

• Number of firms
• Size of firms
• Distribution of firms
• Freedom of entry
• The extent of product differentiation
• Determines how firms interact with each other and how firms can set prices

Question 5

What is the monopolist price setting condition?

Answer 5

• MC = MR
• This is the profit maximisation point

Question 6

What is the perfectly competitive price setting condition?

Answer 6

• P = MC

Question 7

Name some characteristics of Perfect Competition

Answer 7

• Homogenous goods
• No economic profit in the LR
• Many firms
• 0 barriers to entry
• Perfect Knowledge

Question 8

Name some characteristics of Monopolies

Answer 8

• One seller
• Supernormal profit
• High barriers to entry
• Few substitutes
• High market power

Question 9

Name some characteristics of Oligopolies

Answer 9

• A few firms
• Collusion may occur
• High barriers to entry
• Preditory pricing
• Partial market power

Question 10

Name some characteristics of Monopolistic Competition

Answer 10

• Somewhat heterogenous goods
• Many firms
• Some barriers to entry
• Can set some prices

Question 11

What markets are pricing strategies most likely to be in?

Answer 11

• Markets where power can be exercised
• Oligopoly/Monopoly

Question 12

How can advertisement help in competition strategy? What are the two advertisement types?

Answer 12

• Non-Pricing strategy
• Incentive to attract more customers at the expense of others
• 2 types; advertisement to make demand more/less elastic
• MORE: Coupons, weekly ads in papers, end-of-aisle display
• LESS: Quality and experience focus (usually luxury)

Question 13

What is Price Discrimination? How can it be achieved?

Answer 13

• Price Discrimination: The business of selling the sam e good at different prices to different consumers
• High PED, high Price Discrimination
• Firms must have perfect information on PED
• Firms must have some market power
• Resale market must not be present

Question 14

What is 1st Degree Price Discrimination?

Answer 14

• Seller knows maximum price that each individual is willing to pay

Question 15

What is 2nd Degree Price Discrimination?

Answer 15

• Consumers are offered different packages at different prices

Question 16

What is 3rd Degree Price Discrimination?

Answer 16

• Seller can identify two or more separate markets based on time/location …

Question 17

What is predatory pricing?

Answer 17

• Large incumbent firms set prices deliberately high to drive out other firms (rivals or entrants)
• This is illegal in many countries and UBER was charged with this

Question 18

What is limit pricing?

Answer 18

• Incumbent firms charge lower prices to deter others from entering a market
• Entrants see a low price and believe prices will lower when they enter a market- won’t cover sunk costs
• Incumbent believes it is better to be a monopoly at limit price than share at duopoly price
• This is seen in a lower AC curve

Question 19

What are the factors that determine a limit price?

Answer 19

• Cost differences
• Demand level
• Elasticity
• Extent of economies of scale
• Expected reaction of other firms

Question 20

When should limit pricing be pursued?

Answer 20

• PV(LP) > PV(profit max)
• Dependant on discount rate and a firm’s objective
• Limit pricing if there is a lot of uncertainty about the entrant, incumbent and imperfect information

Question 21

What is bundling?

Answer 21

• Combination of goods sold at below market price than if they were sold separately
• Meal deal, Netflix Bundles
• Incumbent firm could be a monopoly in one market, but feel threatened in another market

Question 22

What is new product pricing? What are the two different strategies?

Answer 22

• The firm must price the product and find a promotional mix that will maximise profits, with the difficulty of estimating demand and costs
• The two strategies are skimming prices and penetrating prices

Question 23

What are Skimming Prices? Provide a small outline of this

Answer 23

• The firm intially set a high price to satisfy high demand levels and then reducing the price over time
• This recovers costs quickly and allows for large SR profits
• Demand is more inelastic in the SR, so setting high initial prices ‘skims’ market segments
• The firm must intent to leave the market in the SR

Question 24

What are Penetration Prices? Provide a small outline of this

Answer 24

• Setting a low price to gain market share and deter any entry, hence making low (possibly negative) profits in the LR
• High PED in the SR
• Significant EoS, entering at a large scale reduces LRAC
• Firm’s objective is to stay in the market in the LR

Question 25

What does the Product Life Cycle Framework suggest?

Answer 25

- Different pricing points within a product life-cycle - It should always above the Vc - Changes in the price is reflected by changes in firm's objectives

Question 26

What happens in practice when firms try to price?

Answer 26

- Often firms do not use marginalist principles, do not seek to maximise profits and operate in oligopoly markets - This means: P = AVC + FC (overheads) + Profit Margin - AC pricing might be consistent with the profit maximisation model if the profit margin added varies with elasticity - This isn't always the case: the method is convenient/simple, safe/reliable and doesn't account for inflation

Question 27

How does pricing on the internet work?

Answer 27

- E-business cuts distribution costs, reduces retail margins and introduces effective differential pricing - Issues include anonymity of buyers/sellers, fraud, poor quality

Question 28

What are Learning Curves? Describe the graph

Answer 28

- Knowledge gained from experience that can be used to improve the production process, increasing efficiency and reducing costs - Learning curves reflects AC reduction over time - This means that the curve shifts downwards and the difference between the curves are the Learning effects - DMR on AC curve - Learning Curves help forecast costs, improve pricing decisions and give big firms chances to learn

Question 29

What are learning rates? Give the formula for this

Answer 29

- Learning Rates: A constant % in AC as cumulative output rises - This % represents the proportion by which unit costs decline as cumulative output doubles - L = (1 - AC2/AC1) x 100% - OR; AC2 = AC1 x (1 - L/100%) - If the cost function C=aQ^b, it must be made log-linear

Question 30

When are learning curves the most efficient?

Answer 30

- Learning effects are high - New industries, new tech/products - Markets with standardised goods - Where management controls costs and monitor potential sources of increased productive efficiency