Deck 11: Pricing Strategies for Firms With Markel Power

Question 1

Based on the best available econometric estimates, the market elasticity of demand for your firm's product is -1.50. The marginal cost of producing the product is constant at $75, while average total cost at current pro4242-11-2ECCQ.htmlduction lev­els is $200. Determine your optimal per unit price if:
a. You are a monopolist.
b. You compete against one other firm in a Cournot oligopoly.
c. You compete against 19 other firms in a Cournot oligopoly.

Answer 1

Elasticity of demands is the percentage change in quantity demand of the product due to percentage change in the price of the commodity.
Marginal cost is the cost of producing one more unit of output. Average total cost is total cost divided by quantity of output produced by the firm.
As per information, market elasticity of demand is -1.5. Marginal cost is $75, and average cost is $200.
(a)For monopoly marginal revenue is given by, Here, is price elasticity of demand, is price, and is marginal revenue.
At profit maximizing level of output, marginal revenue is equal to the marginal cost for monopoly firm, so Hence, is optimal per unit price.
(b)For Cournot Oligopoly, profit maximizing price is given by Here, is price, is number of firms, 0
is market elasticity of demand, and 1
is marginal cost.
There are only two firms in the market, so 2
Hence, 3
is optimal per unit price.
(c)For Cournot Oligopoly, profit maximizing price is given by 4
Here, 5
is price, 6
is number of firms, 7
is market elasticity of demand, and 8
is marginal cost.
There are twenty firms in the market, so 9
Hence, 0
is optimal per unit price.

Question 2

Based on the following graph (which summarizes the demand, marginal revenue, and relevant costs for your product), determine your firm's opti­mal price, output, and the resulting profits for each of the following scenarios: 11eb4f3d_2b18_153d_a4ce_f321e2638883
a. You charge the same unit price to all consumers.
b. You engage in first-degree price discrimination.
c. You engage in two-part pricing.
d. You engage in block pricing.

Answer 2

(a)The given graph shows the monopoly market situation as the demand curve is a downward sloping curve.
For the purpose of determining the equilibrium level of output, the profit-maximizing condition of the monopoly firm is given by: From the graph, this implies that the monopoly level of equilibrium output level is 4
Under the condition of profit-maximization, the equilibrium monopoly price follows from the demand curve at the equilibrium monopoly quantity.
From the graph, this implies that the monopoly level of equilibrium price is $60
Hence, the monopoly profit is given by: Thus, the firm's optimal price is $60 per unit, optimal output is 4 units and the resulting profit is $160
(b)The case is of first-degree price discrimination in which the firm charges the maximum price that the consumer is willing to pay for each unit of the good purchased such that all consumer surpluses is extracted and the firm earns the highest possible profits.
From the graph, it is evident that the firm would charge $90 for the 1 st unit, $80 for the 2 nd unit, $70 for the 3 rd unit, $60 for the 4 th unit, $50 for the 5 th unit, $40 for the 6 th unit, $30 for the 7 th unit and $20 for the 8 th unit. Th firm would not sell beyond the 8 th unit as the marginal cost is greater than the price followed from the demand curve. That means, for n th unit, the firm shall charge a price followed from the demand curve.
Hence, the profit earned by the firm under first-degree price discrimination is equal to the consumer surplus, which is given by: Thus, the firm's optimal price is the maximum price that the firm could charge as followed from the demand curve, optimal output is 8 units and the resulting profit is $320
(c)Under the case of two-part pricing, the firm charges a fixed fee for the right to purchase its goods and a per-unit charge for each unit purchased.
Like the firm practicing first-degree price discrimination, the firm under the two-part pricing extract all consumer surplus from consumers in the form of fixed fee and charge a per-unit price equal to the marginal cost.
Hence, under the two-part pricing, the fixed fee charged by the firm is $320 and a per-unit price of $20. The optimal output sold by the firm under two-part pricing is 8 units.
The profit earned by the firm under two-part pricing is given by: Thus, the firm's optimal price is $320 as the fixed fee and $20 per unit, optimal output is 8 units and the resulting profit is $320
(d)Under the case of block pricing, the firm charges the amount equal to the total value that the consumer places on the given bundle of a good.
From the graph, it is evident that the firm would sell 8 units as beyond the 8 th unit, the marginal cost exceeds the price that follows from the demand curve.
The total value placed by the consumer for the bundle of 8 units of good is given by: That means, the firm would charge a price of $480 for the bundle of 8 units of the good under block pricing. The profit earned by the firm under block pricing is given by: Thus, the firm charges $480 for the bundle of 8 units of the good and makes a profit of $320 under block pricing.

Question 3

You are the manager of a firm that charges customers $16 per unit for the first unit purchased, and $12 per unit for each additional unit purchased in excess of one unit. The accompanying graph summarizes your relevant demand and costs.
a. What is the economic term for your firm's pricing strategy
b. Determine the profits you earn from this strategy.
c. How much additional profit would you earn if you were able to perfectly price discriminate 11eb4f3d_2b19_26b4_a4ce_499dbcd62105

Answer 3

It is given that the firm charges customers $16 per unit for the first unit purchased and $12 per unit for each additional unit purchased in excess of one unit.
a)From the given statement it is clear that the firm is following the practice of posting a discrete schedule of declining prices for different ranges of quantities.
Thus, it indicates towards the fact that the firm is following second-degree price discrimination related pricing strategy.
b)From the graph, it is evident that the firm would not sell beyond 3 rd unit at a price of $12 per unit.
It means that, following the second-degree price discrimination, the pricing strategy adopted by the firm is $16 per unit for the first unit purchased and $12 per unit for each additional unit purchased in excess of one unit till 3 rd unit.
Write the formulae for calculating profit as follows: Calculate the profit earned by the firm from second degree price discrimination as follows: Thus, the profit earned by the firm from the second-degree price discrimination related pricing strategy is .
c)Under the perfect price discrimination, the firm would follow first-degree price discrimination in which the firm charges the maximum price that the consumer is willing to pay for each unit of the good purchased such that all consumer surpluses is extracted and the firm earns the highest possible profits equal to the consumer surplus. That means, the additional profit of would be earned if the firm were able to perfectly price discriminate by following first-degree price discrimination than by following second-degree price discrimination.
Thus, the additional profit that could be earned if the firm will able to perfectly discriminate is .

Question 4

You are the manager of a monopoly that sells a product to two groups of consumers in different parts of the country. Group 1 's elasticity of demand is -2, while group 2's is 6. Your marginal cost of producing the product is $10.
a. Determine your optimal markups and prices under third-degree price dis­crimination.
b. Identify the conditions under which third-degree price discrimination enhances profits.

Question 5

You are the manager of a monopoly. A typical consumer's inverse demand function for your firm's product is P = 100 - 20 Q , and your cost function is 20 Q.
a. Determine the optimal two-part pricing strategy.
b. How much additional profit do you earn using a two-part pricing strategy compared with charging this consumer a per-unit price

Question 6

A monopoly is considering selling several units of a homogeneous product as a single package. Atypical consumer's demand for the product is Q d = 50 .25 P , and the marginal cost of production is $120.
a. Determine the optimal number of units to put in a package.
b. How much should the firm charge for this package

Question 7

A large firm has two divisions: an upstream division that is a monopoly supplier of an input whose only market is the downstream division that produces the final output. To produce one unit of the final output, the downstream division requires one unit of the input. If the inverse demand for the final output is P = 1,000 80 Q would the company's value be maximized by paying upstream and downstream divisional managers a percentage of their divisional profits Explain.

Question 8

According to some translations, Nobel Laureate Albert Einstein once said, "God does not play dice with the universe." Does this mean that a profit- maximizing firm would never use something like dice or a roulette wheel to help shape its pricing decisions Explain.

Question 9

Does the presence of online auction sites, such as eBay, make it easier or harder for traditional retailers and wholesalers to engage in profitable price discrimination Explain.

Question 10

You are the owner of a local Honda dealership. Unlike other dealerships in the area, you take pride in your "No Haggle" sales policy. Last year, your dealership earned record profits of $1.5 million. However, according to the local Chamber of Commerce, your earnings were 10 percent less than either of your competitors. In your market, the price elasticity of demand for midsized Honda automobiles is 4.5. In each of the last five years, your dealership has sold more midsized automobiles than any other Honda dealership in the nation. This entitled your dealership to an additional 30 percent off the manufacturer's suggested retail price (MSRP) in each year. Taking this into account, your marginal cost of a midsized automobile is $11,000. What price should you charge for a midsized automobile if you expect to maintain your record sales

Question 11

You are a pricing analyst for QuantCrunch Corporation, a company that recently spent $10,000 to develop a statistical software package. To date, you only have one client. A recent internal study revealed that this client's demand for your software is Q d = 100 0. 1 P and that it would cost you $500 per unit to install and maintain software at this client's site. The CEO of your company recently asked you to construct a report that compares (1) the profit that results from charging this client a single per-unit price with (2) the profit that results from charging $900 for the first 10 units and $700 for each additional unit of software purchased. Construct this report, including in it a recommendation that would result in even higher profits.

Question 12

You are the manager of a local sporting goods store and recently purchased a shipment of 60 sets of skis and ski bindings at a total cost of $30,000 (your wholesale supplier would not let you purchase the skis and bindings separately, nor would it let you purchase fewer than 60 sets). The community in which your store is located consists of many different types of skiers, ranging from advanced to beginners. From experience, you know that different skiers value skis and bindings differently. However, you cannot profitably price discriminate because you cannot prevent resale. There are about 20 advanced skiers who value skis at $350 and ski bindings at $250; 20 intermediate skiers who value skis at $250 and ski bindings at $375; and 20 beginning skiers who value skis at $175 and ski bindings at $325. Determine your optimal pricing strategy.

Question 13

According to the Cahner's In-Stat Group, the number of worldwide wireless phone subscribers will soon reach the 1 billion mark. In the United States alone, the number of wireless subscribers is projected to grow by almost 17 million subscribers per year for the next five years. Contributing to the extensive growth are lower prices, larger geographic coverage, prepaid services, and Internet enabled phones. While the actual cost of a basic wireless phone is about $75, most wireless carriers offer their customers a "free" phone with a one-year wireless service agreement. Is this pricing strategy rational Explain.

Question 14

The American Baker's Association reports that annual sales of bakery goods last year rose 15 percent, driven by a 50 percent increase in the demand for bran muffins. Most of the increase was attributed to a report that diets rich in bran help prevent certain types of cancer. You are the manager of a bakery that produces and packages gourmet bran muffins, and you currently sell bran muffins in packages of three. However, as a result of this new report, a typical consumer's inverse demand for your bran muffins is now P = 3 .5 Q. If your cost of producing bran muffins is C ( Q ) = Q , determine the optimal number of bran muffins to sell in a single package and the optimal package price.

Question 15

You own a franchise of rental car agencies in Florida. You recently read a report indicating that about 80 percent of all tourists visit Florida during the winter months in any given year, and that 60 percent of all tourists traveling to Florida by air rent automobiles. Travelers not planning ahead often have great difficulty finding rental cars due to high demand. However, during nonwinter months tourism drops dramatically and travelers have no problem securing rental car reservations. Determine the optimal pricing strategy, and explain why it is the best pricing strategy.

Question 16

Blue Skies Aviation is a manufacturer of small single-engine airplanes. The company is relatively small and prides itself on being the only manufacturer of customized airplanes. The company's high standard of quality is attributed to its refusal to purchase engines from outside vendors, and it preserves its competitive advantage by refusing to sell engines to competitors. To achieve maximum efficiencies, the company has organized itself into two divisions: a division that manufactures engines and a division that manufactures airplane bodies and assembles airplanes. Demand for Blue Skies' customized planes is given by P = 610,000 2,000 Q. The cost of producing engines is 11eb4f3d_2b1e_cc41_a4ce_ff1792f9c474
; and the cost of assembling airplanes is C a (Q) = 10,000 Q. What problems would occur if the managers of each division were given incentives to maximize each division's profit separately What price should the owners of Blue Skies set for engines in order to avoid this problem and maximize overall profits

Question 17

As a manager of a chain of movie theaters that are monopolies in their respective markets, you have noticed much higher demand on weekends than during the week. You therefore conducted a study that has revealed two different demand curves at your movie theaters. On weekends, the inverse demand function is P = 15 0.001 Q ;on weekdays, it is P = 10 0.001 Q. You acquire legal rights from movie producers to show their films at a cost of $20,000 per movie, plus a $2 "royalty" for each movie goer entering your theaters (the average moviegoer in your market watches a movie only once). Devise a pricing strategy to maximize your firm's profits.

Question 18

Many home improvement retailers like Home Depot and Lowes have low- price guarantee policies. At a minimum, these guarantees promise to match a rival's price, and some promise to beat the lowest advertised price by a given percentage. Do these types of pricing strategies result in cutthroat Bertrand competition and zero economic profits If not, why not If so, suggest an alternative pricing strategy that will permit these firms to earn positive economic profits.

Question 19

BAA is a private company that operates some of the largest airports in the United Kingdom, including Heathrow and Gatwick. Suppose that BAA recently commissioned your consulting team to prepare a report on traffic congestion at Heathrow. Your report indicates that Heathrow is more likely to experience significant congestion between July and September than any other time of the year. Based on your estimates, demand is 11eb4f3d_2b20_52fe_a4ce_a7af2cf88f39
, where 11eb4f3d_2b20_52ff_a4ce_23f87fc4f72c
is quantity demanded for runway time slots between July and September. Demand during the remaining nine months of the year is 11eb4f3d_2b20_7a10_a4ce_ebdaa53c6034
where 11eb4f3d_2b20_7a11_a4ce_cdb15f10e9f1
is quantity demanded for runway time slots. The additional cost BAA incurs each time one of the 90 different airlines utilizes the runway is £950 provided 70 or fewer airplanes use the runway on a given day. When more than 70 airplanes use Heathrow's runways, the additional cost incurred by BAA is £5 billion (the cost of building an additional runway and terminal). BAA currently charges airlines a fixed fee of £1,412.50 each time the runway is utilized. As a consultant to BAA, devise a pricing plan that would enhance Heathrow's profitability.

Question 20

Suppose the European Union (EU) is investigating a proposed merger between two of the largest distillers of premium Scotch liquor. Based on some economists' definition of the relevant market, the two firms proposing to merge enjoyed a combined market share of about two-thirds, while another firm essentially controlled the remaining share of the market. Additionally, suppose that the (wholesale) market elasticity of demand for Scotch liquor is -1.2 and that it costs $15.40 to produce and distribute each liter of Scotch. Based only on these data, provide quantitative estimates of the likely pre- and postmerger prices in the wholesale market for premium Scotch liquor. In light of your estimates, are you surprised that the EU might raise concerns about potential anticompetitive effects of the proposed merger Explain carefully.

Question 21

An analyst for FoodMax estimates that the demand for its "Brand X" potato chips is given by In 11eb4f3d_2b21_3d6e_a4ce_89eda39329f2
ln A X , where Q X and P X are the respective quantity and price of a four-ounce bag of Brand X potato chips, P Y is the price of a six-ounce bag sold by its only competitor, and A X is FoodMax's level of advertising on brand X potato chips. Last year, FoodMax sold 5 million bags of Brand X chips and spent $0.25 million on advertising. Its plant lease is $2.5 million (this annual contract includes utilities) and its depreciation charge for capital equipment was $2.5 million; payments to employees (all of whom earn annual salaries) were $500,000. The only other costs associated with manufacturing and distributing Brand X chips are the costs of raw potatoes, peanut oil, and bags; last year FoodMax spent $2.5 million on these items, which were purchased in competitive input markets. Based on this information, what is the profit-maximizing price for a bag of Brand X potato chips

Question 22

You manage a company that competes in an industry that is comprised of five equal-sized firms that produce similar products. A recent industry report indicates that the market is fairly saturated, in that a 10 percent industrywide price increase would lead to a 22 percent decline in units sold by all firms in the industry. Currently, Congress is considering legislation that would impose a tariff on a key input used by the industry. Your best estimate is that, if the leg­islation passes, your marginal cost will increase by one dollar. Based on this information, what price increase would you recommend if the tariff legislation is passed by Congress Explain.