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Managerial Tools from the Economist Toolkit: some advanced microeconomics Miguel URDANOZ 10/10/2015 www.tbs-education.fr
Managerial Tools from the
Economist Toolkit: some advanced
microeconomics
Miguel URDANOZ
10/10/2015
www.tbs-education.fr
 

Pricing Strategies - BRICK7

2

 
 

Uniform pricing Price Discrimination:

First Degree Second Degree Third Degree

Bundling Dynamic Price Discrimination

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

Uniform pricing with market power

 

3

 
 

What is going to determine your price?

 

Facing a downward sloping demand curve, a firm has a trade-off between

 

high-margin/small volume low-margin/large volume

 

The price-sensitivity of consumers demand determines which of the two strategies is the optimal one

 
 

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

 

2015

 
 

Price-sensitivity of consumers (2)

 

4

 
 

Price p

D 1
D
1

p 0

p 1

 

q 0

q 1

Quantity q

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

 

2015

 

Price-sensitivity of consumers

 

5

 
 

Elasticity

 

Demand price elasticity is the ratio of a relative quantity variation to a relative price variation, in absolute value (i.e. an elasticity is always positive even if demand decreases with price)

 

= |(Q/Q) / (P/P)|

 

If the price relative variation is 1% (P/P = 1), the relative quantity variation is Q/Q %

 

If 0 < < 1, demand is inelastic: a price increase of 1% reduces the volume by less than 1%

If 1 < , demand is elastic and an increase in price by 1% reduces the volume sold by more than 1%

 

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 
 

Price-sensitivity of consumers (1)

 

6

 
 

Elasticity

 

Demand price elasticity is the ratio of a relative quantity variation to a relative price variation, in absolute value (i.e. an elasticity is always positive even if demand decreases with price)

 

= |(Q/Q) / (P/P)|

 

If the price relative variation is 1% (P/P = 1), the relative quantity variation is Q/Q %

 

If 0 < < 1, demand is inelastic: a price increase of 1% reduces the volume by less than 1%

If 1 < , demand is elastic and an increase in price by 1% reduces the volume sold by more than 1%

 

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

Price-sensitivity of consumers (2) 7 Price p p 0 ∆p 1 p 1 ∆q 1 D
Price-sensitivity of consumers (2)
7
Price p
p 0
∆p 1
p 1
∆q 1
D
1
q 0
q 1
Quantity q
Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)
2015
 

Price-sensitivity of consumers (3)

8

 
 

With an inelastic demand, the strategy should be a high price (margin) With an elastic demand, the strategy should be volume (and a low margin) Elasticity is not constant: changes in time and over demand Other elasticities can be computed:

Cross-price: substitutes (+) or complements (-) Income: normal and inferior goods

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

Example: Railroads

 

9

 
 
 

Author

Year of

Market

Price Elasticity

 

Publication

Short run

Long run

Behrens and

London-

Pels

2009

Paris

-0.41 -0.56

Wardman

2006

UK

-0.99

Ivaldi and

Cologne-

Vibes

2005

Berlin

-1.21 -1.29

Asteriou et al.

2005

UK

-0.18 -0.2

-0.7 -1.01

Van Vuuren et

2002

Netherland

-1.37

Rietveld Wardman et al.

1996

UK

-0.59

Goodwin et al.

1992

UK

-0.65 -0.79

-1.08

De Rus Ben-Akiva &

1990

Spain

-0.18 -0.41

Morikawa Owen and

1990

Netherland

-0.15 -1.50

Phillips

1987

UK

-0.69

-1.08

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

How to measure elasticity of demand

10

 
 

Surveys and/or interviews

Statistical analysis: Study previous changes in prices and their effect on demand

Pricing experiments:

can only be conducted in certain markets characterized by relatively low demand with excess capacity

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

Optimal uniform price of a firm with market power

11

 
 

Average and marginal revenues

When increasing the price it charges, a firm with market power must integrate the reduction in volume and vice-versa

The marginal revenue of a price increase decomposes as a gain in price when increasing slightly the quantity, and a loss in volume

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

Optimal uniform price of a firm with market power 12 Price P When lowering the price
Optimal uniform price of a firm with
market power
12
Price P
When lowering the price from P 0 to P 1 , a monopoly
looses (P 0 - P 1 ) x Q’, and gains P 1 x (Q 1 - Q 0 )
The revenue variation is equal to
∆R = P 1 x ∆Q - ∆P x Q 0
Relatively to the increase in quantity, the variation is
Decrease in
∆R / ∆Q = P 1 – (∆P / ∆Q ) x Q 0
< P 1
revenue
P
0
Demand
What is the variation of the cost of production,
relatively to a production increase? Price to fix?
∆P
P
Increase in
1
revenue
Q 0
Q 1
Quantity Q
∆Q
Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)
2015
Optimal uniform price of a firm with market power 13 Price (€) Marginal Revenue: “Twice as
Optimal uniform price of a firm with
market power
13
Price (€)
Marginal Revenue: “Twice as steep rule” applies
only for linear demand functions
Demand
100
Marginal revenue
When Marginal Revenue = 0, total revenue is at
its maximum level
>1 >1 >1 >1
What about costs and profits?
=1
50
<1 <1 <1 <1
0
Quantity
5000
10000
(units)
0
Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)
2015
 

MR vs MC

14

 
 

Marginal Revenue (MR):

Change in Total revenue given a one-unit (or marginal) change in quantity

Marginal Cost (MC):

Change in Total cost given a one-unit (or marginal) change in quantity Is Marginal cost the same as average cost?

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

Optimal uniform price of a firm with market power 15 Price (€) As long as the
Optimal uniform price of a firm with
market power
15
Price (€)
As long as the additional revenue from selling an
extra unit exceed the extra cost of production of
this unit, the monopoly may earn a positive
additional profit on this unit …
The production (and market price) of a monopoly
100
Demand
must be such that the marginal revenue of its
production is equal to its marginal cost
Marginal revenue
55
M
M
P
MC
1
Monopoly’ Marginal cost
=
M
P
ε
10
0
Quantity
ε
M
M
4500
10000
(units)
P
=
MC
0
ε
− 1
“Monopoly” Equilibrium
Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)
2015
 

Competitive pricing

 

16

   
 

Price (€)

If at Q 0 price is over marginal cost, firms increase their production or new firms enter the market

Competitive Demand
Competitive Demand
 

Consider a very small change in production, say Q = 1 unit. To exhaust all gains from trade, ∆π /

100

Q = C / Q for Q = 1

P

0

 

P

 

1

Competitive Supply

 

10

0

Competitive Equilibrium

 

Quantity

Q 0

Q 1

9000

10,000

(units)

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

Welfare

17

 
 

Inverse demand measures willingness to pay Consumer surplus: difference between willingness to pay and actual price paid Welfare: profit of the firm + consumer surplus Monopoly: Dead-weight loss Monopoly: Cost distortions Rent seeking behaviour

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

Market power

18

 
 

Degree of market power of a firm can be measured by its ability to increase price without loosing a too large part of its customers

Perfect Competition Measures of market power

Perfect Competition Measures of market power

Monopoly

 

k

=

i = 1

s

i

 

Concentration Index

C

k

   

n

 

Herfindahl Hirshman Index: HHI

HHI

=

 

2

s

i

 

i = 1

 

SSNIP test: Small but Significant and Non-transitory Increase in Price

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

19

Pricing strategies, Price and Non-price Discrimination

 

How to price when the firm enjoys a large degree of market power?

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

Introduction

20

 
 

Price Discrimination: Two units of the same physical good are sold at different prices, either to the same consumer or to different consumers.

Stigler (2004): Discrimination exists when similar products are sold at prices that are in different ratios to their marginal costs.

Why?

Consumers are different: willingness to pay varies (price sensitivity) Some consumers receive a surplus with uniform pricing

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

Requirements:

21

 
 

Is it legal? Market Power

Firm needs information on demand: required information varies with type of price discrimination

Instruments: different types of price discrimination Limits: No resale/arbitrage possibilities

Goods: taxes, transportation costs, law Services: train/air tickets

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 
 

Introduction

22

 
 

If individuals are (almost) identified, tailored offers (1 st degree) Else group tariffs are possible (2 nd degree)

If individuals are not identified but types are known, another (3 rd degree)

Bundling is another tool to discriminate consumers (non price)

Example: Yield Management and the Airline industry

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

Price Discrimination and Yield Management

23

 
 

Tourists vs. business travelers Offer discounts to early purchasers of tickets The danger of segmented pricing

Lower fare passengers may largely take the available inventory

So, yield management system is used to adjust seat inventory (seat allocation among different price levels based on expected demand)

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

First degree (or perfect) price discrimination

 

24

 
 

DEFINITION: Perfect price discrimination refers to a situation in which a seller

 

observes perfectly the characteristics of its customers and is able to taylor the tariff

specifically for each of them

 

DIRECT CONSEQUENCE: if buyers do not have any market power, it is possible to

 

extract the entire profit created by the purchase of the product from each of them

 

REAL LIFE EXAMPLES: Past/Present: Doctors in rural areas.

Future:Advertising in Google is context sensitive, databases on

our purchases may allow us to get personal mail/email offers or

pay different prices.

HBR, October 2012 Getting Control of Big Data

REAL LIFE EXAMPLES: Past/Present: Doctors in rural areas. Future:Advertising in Google is context sensitive, databases on
 
 

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

Two possible cases

25

 
 

Unitary demand per customer

Example: different hostel rates

Multiple unit demand per customer:

Take it or leave it package Two part tariff (non linear pricing)

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 
 

A simple example to fix ideas

26

 
 

Producer P faces two customers, C 1 and C 2 and knows their demand

Customers behave competitively, and cannot resell the product to each other

Each customer has a demand that varies with price

V 1 (Q 1 ) = 100 – Q 1 and V 2 (Q 2 ) = 50 – Q 2

Unit cost of production of P is 10

IDEAL PRICES OF PRODUCER P ?

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

First Degree Price Discrimination 27 Price (€) PARTICIPATION CONSTRAINTS: Price (€) Fee paid by C 1
First Degree Price Discrimination
27
Price (€)
PARTICIPATION CONSTRAINTS:
Price (€)
Fee paid by C 1 lower than A 1 ,
50
Fee paid by C 2 lower than A 2
100
Max.
Fee A 2
10
Unit production cost of U
Max.
Fee A 1
Quantity
0
(units)
40
50
0
10
Unit production cost of U
0
Quantity
90
100
(units)
0
Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)
2015
 

Third degree (or group) price discrimination

 

28

 
 

Some characteristics are identifiable, and possibly verifiable (i.e. it is possible to verify whether an individual claiming to have the characteristic is lying or not)

Different groups pay different prices:

 
 

More price sensitive consumers pay a lower price

Less price sensitive consumers pay a higher price

 

Examples of characteristics

 
 

age,

employment status (including student),

club membership, …

 

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

Third degree price discrimination

29

 
 

Maximize profit for each group Examples:

Cinema

Zara

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

Ipad prices and taxes 30 Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School) 2015
Ipad prices and taxes
30
Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)
2015
Iphone 5 31 Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School) 2015
Iphone 5
31
Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)
2015
32 Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School) 2015
32
Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)
2015
33 Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School) 2015
33
Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)
2015
34 Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School) 2015
34
Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)
2015
35 Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School) 2015
35
Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)
2015
36 Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School) 2015
36
Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)
2015
 

Example: Coca Cola

37

 
 

Coca-Cola announces that it is developing a "smart" vending machine. Such machines are able to change prices according to the outside temperature.

Suppose for the purposes of this problem that the temperature can be either "high" or "low". On days of

"high" temperature, demand is given by Q = 280 - 2p, where Q is the number of cans of Coke sold during the

day and p is the price per can measured in cents.

On

days of "low" temperature, demand is only Q = 160 - 2p. The marginal cost of a can of coke is 20 cents.

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 
 

Example: Coca Cola

38

 
 

Suppose that Coca-Cola installs a "smart" vending machine and thus is able to charge different prices for Coke on "hot" and "cold" days. What price should Coca-Cola charge on a "hot" day? What price should Coca-Cola charge on a "cold" day?

Alternatively, suppose that Coca-Cola continues to use its normal vending machines which must be programmed with a fixed price, independent of the weather. What is the optimal price for a can of Coke? Assume there are an equal number of days with "high" and "low" temperature.

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

Example: Coca Cola

 

39

 
 

What would Coca-Cola's profits be under constant and weather-variable prices? How much would Coca-Cola be willing to pay to enable its vending machine to vary prices with the weather, that is, to have a "smart" vending machine?

Applied by Coca Cola in 1999

 
 

"A cynical ploy to exploit the thirst of faithful customers" (San Francisco Chronicle)

"Lunk-headed idea", (Honolulu Star-Bulletin) "Soda jerks" (Miami Herald)

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 
 

Welfare

 

40

 
 

Firm is better off (in the worst case the firm is as well off)

Consumers in inelastic markets are worse off Consumers in highly elastic markets are better off

 

In some cases no one is worse and some improve:

 

cases of non-served markets

 

Intermediary goods markets: Robinson Patman Act

 

Protect small business from “unfair” advantages possessed by large buyers

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

2 nd Degree price discrimination

41

 
 

Demand with heterogenous consumers

Proposed personalized packages or bundles:

perfect discrimination

What if monopolist can not identify each consumer’s demand function

Do we offer only one bundle? Offer a menu of bundles

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

2 nd Degree price discrimination

 

42

 
 

A simple example to fix the ideas …

 

Producer P faces to customers, C

1

and C , knows it but cannot tell

2

whether any customer coming to the shop is high sensitive to prices or not

Customers behave competitively

Each customer has a demand that varies with price

 

V 1 (Q 1 ) = 100 – Q 1 and V 2 (Q 2 ) = 50 – Q 2

 

Unit cost of production of P is 10

IDEAL PRICES OF PRODUCER P ?

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

2 nd Degree price discrimination : example 43 Price (€) Price (€) 50 100 Max. Fee
2 nd Degree price discrimination :
example
43
Price (€)
Price (€)
50
100
Max.
Fee A 2
10
Unit production cost of P
Max.
Fee A 1
Quantity
0
(units)
40
50
0
10
Unit production cost of P
0
Quantity
90
100
(units)
0
Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)
2015
2 nd Degree price discrimination :
example
44
Price (€)
Under the tariffs offered in PP, T i (q)= A i +
Price (€)
Max. Fee
10 x q for any i=1,2. All customers would
paid by C 1
choose tariff T 2 (q). Anything better for the
50
producer?
100
Max.
Fee A 2
Min.
10
Unit production cost of U
payoff
Quantity
of C 1
0
(units)
40
50
0
10
Unit production cost of U
0
Quantity
90
100
(units)
0
Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)
2015
 

2 nd Degree price discrimination

 

45

 
 

The generic expression of the tariff is

 
 

T i (q) = F i + v i x q

 

If the producer wants customer i to use the tariff tailored for himself, customer i must earn a larger payoff than if he chooses the tariff of customer j

Known as the INCENTIVE COMPTABILITY CONSTRAINT

If customers incentives are not compatible with a firm’s objectives, then the firm will miss its goal

 

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 
 

An example of possible tariff

 

46

 
 

Increase the unit price for the tariff taylored

 

for C 2

(i.e. w 2 > 10), leave him indifferent

between participating or not (i.e. A 2 maximal), set w 1 =10 but leave him a positive payoff

 

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

An example of possible tariff 47 Price (€) The loss accepted by P due to the
An example of possible tariff
47
Price (€)
The loss accepted by P due to the increase
Price (€)
Max. Fee paid
by C 1 under T 2
in w 2 is compensated by the extra money
raised on C 1 . Net
gain = 150 € for P.
50
100
Max. Fee
Variable profit on C 2
A 2
20
Min. payoff
of C 1 under
10
Loss on C2 =
Quantity
(40 – 10) x
0
T 2
(units)
(20 –10)/2
30
50
0
as this
Gain for C 1 if he buys
20 = w 2
amount was
at w 1 =10 instead of w 2
10 = w 1
obtained in
= 20. How large A 1 ?
fee A 2 in the
0
Quantity
previous
80
90
100
(units)
0
tariff with
unit price w
Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)
2015
= c for i=1,2
 

Example: phone companies

 

48

 
 

Consider the good offered by the monopoly is a mobile phone, and that two contracts can be offered :

 

a contract with a small fee A 2 and a high per unit cost of communication w 2 (extreme form is Pay-As-You-Go with A 2 = 0 and w 2 large)

and a regular contract with a fixed fee A 1 (larger than 0 if the other contract is PAYG) and a smaller per unit cost of the communication minute w 1 closer to the unitary cost

The groups of consumers are talkative (group 1) and non- talkative (group 2) so that talkative is more valuable for the firm than non-talkative

You cannot force consumer to buy one contract or the other, you have to let them self-select (i.e. choose the one they prefer)

 

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

Optimal tariffs

49

 
 

Optimum:

Customer C 2 (low demand consumer) is charged his maximum willingness to pay

Customer C 1 (high demand consumer) is charged the highest price that makes him choose tariff 1 rather than tariff 2

Or sell only to high demand consumers: corner solution

You need to design at most as many tariffs as groups of consumers

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

Bundling

50

 
 

A multi-product monopoly can use consumers preferences to sell bundles and extract more surplus

Homogeneous goods Heterogeneous goods

Pure Bundling: selling products only as a bundle, not individually

Mixed Bundling: selling products as a bundle and individually

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

Bundling

51

 
 

Assume 2 products, A and B, that can be separately sold at p A and p B , or together at p AB < p A + p B , with p AB > p A and p AB > p B

Consumers willingness to pay are v A , v B , or v A +v B Then depending on correlations between willingness to pay bundling will increase profits or not …

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

Bundling

 

52

 
 

v

A

v

A

p A

Consumers Consumers buying A buying A only and B Consumers Consumers buying B not buying only
Consumers
Consumers
buying A
buying A
only
and B
Consumers
Consumers
buying B
not buying
only
 

p A

Consumers Consumers buying A buying A only and B Consumers Consumers buying not buying B only
Consumers
Consumers
buying A
buying A
only
and B
Consumers
Consumers buying
not buying
B only
 
 

p B

v

B

p B

  • v B

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

Bundling

53

 
 

The firm looses some profit on consumers who were buying A and B when sold separately

The firm gains some profit on consumers who are buying the bundle instead of A or B or nothing

Whether the gains exceed the looses depends on the distribution of valuations

If the masses of consumers are mostly on high v A and low v B (or the opposite), bundling is profitable

Roughly valuations must be negatively correlated

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

54 An example: 2 consumers ( Mr Pink and Mr Green ) and 2 goods (A
54
54

An example: 2 consumers (Mr Pink and Mr Green) and 2 goods (A and B), valuations in the table

An example: 2 consumers ( Mr Pink and Mr Green ) and 2 goods (A

Without bundles, the firm is better off fixing p A = 7 (and sell to Mr Green) and p B = 8 (and sell to Mr Pink), raising 15 € of profit

A bundle priced at 9 can be sold twice, raises 18 In that case willingness to pay are negatively correlated

 

A

B

Sum of

valuations

Mr Pink

3

8

11

Mr Green

7

2

9

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

55 Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School) 2015
55
Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)
2015
56 Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School) 2015
56
Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)
2015
 

Price discrimination: next step

 

57

 
 
Price discrimination: next step 57 First 6 months subscription: 50% discount Which kind of price discrimination?
 

First 6 months subscription: 50% discount Which kind of price discrimination? Renewal of subscription: 35% discount

Why

Why

decides to change the discount?

Which kind of price discrimination?

 

Dynamic price discrimination

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 
 

Static versus dynamic analysis

 

58

 
 

Static: You know your demand and costs, and current prices (or quantities) do not affect:

Future

costs

Future

Future

 

equilibrium strategy

level of demand

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

Future costs and strategies

 

59

 
 

Future Costs: price today affects quantity today and this affects costs tomorrow

 

Learning by doing

Strategies

Your price today gives information to the action of your competitor tomorrow

INFORMATION!

INFORMATION!

 

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 
 

Dynamic demand

 

60

 
 

Price today affects demand today, and demand today structures demand tomorrow:

 

Durable goods Temporarily storable goods Experience goods Goods with network externalities: penetration pricing

Prices today affects demand today and this gives information about your present and future demand

Behavior-based price discrimination

 
 

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

Durable goods

61

 
 

Book: Industrial Organization Rules!

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

Durable goods

 

62

 
 

Book: Industrial Organization Rules!

 

P

P 1

MR(Q)
MR(Q)
 
 
 

c

 

Q 1

Q

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

Durable goods

 

63

 
 

Time 2

P

c

c
 
 

Q 1

Q

Durable goods 63 Time 2 P c Q 1 Q Residual Demand Managerial Economics - MBA

Residual Demand

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

Durable goods

 

64

 
 

Time 2

P

P 2

P 2
 

c

 

Q 1

Q 2

Q

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

Intertemporal Price Discrimination

 

65

 
 

Time 3, 4, 5…N

 

P

Q 1 Q 2 Q Q 3 Q 5 4

Q 1

Q 2

Q Q

3

Q 5

4

 

P

1

P

2

P

3

P

P

 

4

5

Q

 

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

Intertemporal Price Discrimination

 

66

 
 

Year 3, 4, 5…N

 

P

P
 

P

1

P

2

P N =c

 

Q 1

Q 2

Q N =Q c

Q

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

Intertemporal Price Discrimination

67

 
 

If you could start again from year 1, would you fix the same price?

Cream skimming or skimming pricing Ex. Movies: Cinema - DVD - Renting - TV

Do you think you can play that kind of strategy? Coase conjecture:

“a durable goods monopolist has no monopoly power if the time between price adjustments is vanishingly small”

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 
 

Coase conjecture

68

 
 

Disney announces DVD

Disney announces DVD
  • 12 weeks after

release on cinema instead of traditional

  • 17 weeks. Why?

Boycott from 40% cinemas in UK and Ireland Managerial Economics - MBA (c) M. Urdanoz (Toulouse

Boycott from 40% cinemas in UK and Ireland

Boycott from 40% cinemas in UK and Ireland Managerial Economics - MBA (c) M. Urdanoz (Toulouse
Boycott from 40% cinemas in UK and Ireland Managerial Economics - MBA (c) M. Urdanoz (Toulouse

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

How to recover market power:

69

 
 

Quality degradation: books, software, airlines Planned obsolescence Limit capacity Production takes time

Reputation: Disney “limited-time available classics boost sales in excess of 400%”

Contractual commitments: best price clause Leasing: problems New customers

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

Bundling and the law of large numbers

 
   
 

Case of firm with 2, 3, 4, … products

 

A firm selling many products can extract consumer surplus if valuations for the different products are independent across products and consumers by:

 

Selling products at unit price close to the marginal costs Charging a fixed fee based on the average valuation across products

Do you know examples of such behavior?

 
Bundling and the law of large numbers Case of firm with 2, 3, 4, … products
Bundling and the law of large numbers Case of firm with 2, 3, 4, … products
Bundling and the law of large numbers Case of firm with 2, 3, 4, … products

Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)

2015

 

70

Law of large Numbers Law of Large Numbers: if ( t t t v , v
Law of large Numbers
Law of Large Numbers: if
(
t
t
t
v
,
v
,
v
)
are the valuations of
1
2
n
consumer t for n products drawn independently from a
distribution with known mean
µ , then if n sufficiently
n
large
t
, is approximately equal to
n× µ
v
i
i = 1
The same applies to any customer as long as valuations
are independently drawn from the same distribution
Key idea: it is easier to predict consumer’s total surplus
than the consumer’s surplus derived from each product
Efficient outcome is approximately achieved and the
firm extract all the gains
Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)
2015
71
How does it works Tariff system: two-parts tariffs * p = c * F = n
How does it works
Tariff system: two-parts tariffs
*
p
= c
*
F
=
n
*
µ
− ∑
i
i
n
i = 1
c
i
Warning: there exists a marginal cost for each
good higher than zero c>0 that makes bundling
result in lower profits and higher deadweight loss
than selling the goods separately
Case of correlated valuations: menu of tariffs
Analysis applies also to situations in which
consumers buy several units of each product
Managerial Economics - MBA (c) M. Urdanoz (Toulouse Business School)
2015
72