II. Pricing and Macroeconomics

A.  Pricing Strategies

1.  Markup pricing

• Set price equal to average cost plus a certain percentage

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a.  Marginal revenue and the price elasticity of demand

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b.  Profit maximization

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2.  Price discrimination

• Charging different prices to different groups of customers, not based on differences in costs of production

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a.  Requirements

(1)  Firms must have some market power - able to set price

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(2)  Must be able to separate customers into different groups with different price elasticities of demand

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(3)  No resale between different groups

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b.  Models of price discrimination

• Total benefit - amount consumers are willing to pay for a product rather than go without

• Consumer surplus - difference between the total amount consumers are willing to pay and the amount they actually pay

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(1)  First-degree price discrimination

• Charge different prices to each consumer

Ex. -

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(2)  Second-degree price discrimination

• Different prices charged for different blocks of output

Ex. -

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(3)  Third-degree price discrimination

• Charge different prices to different groups

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c.  Implementation

(1) Personalized pricing

• First-degree price discriminization

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(2)  Group pricing

• Third-degree price discriminization

• Also achieves:

- Lock-in - develop brand loyalty

- Network externalities - value of a product increases as more people use it

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(3)  Versioning

• Offer different versions of a product

Ex. -

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(4)  Bundling

• Sell multiple products as a bundle

Ex. -

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(5)  Promotional pricing

• Use coupons and sales to lower price for those willing to use them

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(6)  Two-part pricing

• Consumers pay a fixed fee for the right to purchase a product and then pay for the product

Ex. -

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