MANAGERIAL DECISION MAKING

C.  Demand Analysis and Optimal Pricing

1.  Demand

a.  Determinants of demand

(1)  Price

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(2)  Income

(a)  Normal goods

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(b)  Inferior goods

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(3)  Prices of other goods

(a)  Substitute goods (substitutes)

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(b)  Complementary goods (complements)

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(4)  Population

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(5)  Tastes and preferences

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b.  Demand function

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c.  Changes in demand

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2.  Elasticity of demand

Measures the responsiveness of quantity to a change in some factor

E =

a. Price elasticity of demand

E_P =

(1) Calculation

Ep =

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(2) Categorizing goods

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(3) Factors affecting the price elasticity

(a)  Necessity vs. luxury

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(b)  Availability of substitutes

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(c)  Proportion of income spent on good

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(d)  Adjustment time

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(4) Price elasticity and  prediction

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(5) Price elasticity and optimal pricing

(a)  Price elasticity and revenue

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(b)  Revenue maximization

Pure selling problem - variable (marginal) cost is zero or minimal

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3.  Price discrimination

• Selling the same good or service to different buyers at different prices

• Same costs => decision is demand based

a. Necessary conditions

(1)  Different market segments with different demands (price elasticities)

(2)  No reselling between markets

b. Forms of price discrimination

(1) First-degree discrimination - different price for each customer

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(2) Second-degree discrimination - different price schedules based on quantities purchased

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(3) Third-degree discrimination - different prices charged to different market segments

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Ex. -

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4.  Information goods

Ex. - Databases, games, news articles, music, software, entertainment, e-mail, online auctions, brokerage services, Internet transactions, data gathering, etc.

a.  Costly to produce but cheap to reproduce

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b.  Numerous ways for revenue to be earned

• Price per unit

• Royalty

• Subscription

• Pay per use

• Advertising

• Customer lists

c.  Network externalities

• More value to customers with a larger network of customers

Ex. - Wireless phones, airlines, Windows, eBay

• "First-mover" advantage in establishing network

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d.  Customized pricing

• Flexible pricing allows greater market segmentation and price discrimination

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e.  Versioning

• Different versions of a good or service sold

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