Business Economics. Lecture 4
Pricing
Nobuyuki Hanaki
Fall, 2014
Hanaki
Business Economics, L4
Pricing strategies
Firms try to charge different prices to different people to increase
their revenue.
Firms charge different price based on
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Observable (and provable) characteristics of individuals: discount
for students and seniors
Self-selection: buyer’ club and coupons
Differentiating product
Quantity discount
Such strategies are called “Price Discrimination”
Hanaki
Business Economics, L4
Example 1: Hard-cover versus soft-cover
Harry Potter, Volume 7. Hard-cover appeared on 21, July 2007.
Price 28.90 euros
Harry Potter, Volume 7. Soft-cover appeared on 10, July 2008.
Price 10.25 euros
Hanaki
Business Economics, L4
Example 2: Pricing of new DVD at Amazon.fr
“Arrietty, le petit monde” released on 28 Sep. 2011
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Price at the end of July 2011: 19.99 euros
Price on 18 August, 2011: 15:98 euros
Price on 20 September, 2013: 11:98 euros
Hanaki
Business Economics, L4
Example 3: London metro
A subway ride of zone 1 only without Oyster card: 4 GBP
A subway ride of zone 1 only with Oyster card: 1.9 GBP
A bus ride without Oyster card: 2.2 GBP
A bus ride with Oyster card: 1.3 GBP.
Hanaki
Business Economics, L4
Example 3: London metro
Oyster card (for visiter) can be bought
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on line:
http://visitorshop.tfl.gov.uk/oystercard/product/oyster-card.html.
Activation cost 3 euros.
on board to London (for example, I bought mine on my flight to
London.)
at stations in London.
Hanaki
Business Economics, L4
Bottom Line
Suppose there are two types of consumers: one with elastic
demand and the other with much less elastic demand.
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Those with elastic demand are very sensitive to prices.
Those with inelastic demand are not.
QUESTION: to which type of consumer would you charge a higher
price?
To the one with inelastic demand.
PROBLEM: it is not easy to know the type of each customer..
So firms resort to variety of techniques..
Hanaki
Business Economics, L4
Demographic group membership
The simplest strategy
Examples
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Seniors (defined by age) discount
Student (defined by enrollment) discount
Such a strategy works because
On average seniors or students have more elastic demand than
non-seniors or non-students
Also, because the good is not easy to be re-sold to others.
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What if group of students can buy a lot of the good at discounted
price and re-sell them elsewhere?
Such possibility is limited if what is sold at discount price is service
oriented, such as, transportation, dining, etc..
Hanaki
Business Economics, L4
Potential concerns
Charging different price based on demographics raises legal and
ethical concern.
May be not so much, if discount for seniors and students, or those
with less than 26 years old.
What if men are charged different price than women?
What if different prices are charged based on ethnicity?
Can such pricing be legal? or will it be ethical?
Hanaki
Business Economics, L4
Using membership to some clubs
Discounted price for those holding store membership card.
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In a touristic area, it is often the case that many things sold on
stores, even super markets, are quite expensive.
But many are sold at highly discounted price if you have a store
membership card.
One can freely apply for the membership card, but it will be mailed
to the home address of applicants and may takes a few weeks.
What is going on here?
Hanaki
Business Economics, L4
Sales
In late June, many stores in Marseille hold sales.
If you know that things will be cheap in late June, why do you buy
in early June?
Hanaki
Business Economics, L4
The key features
The basic idea is the same as charging higher price to those with
less elastic demand.
Unlike demographic group, the membership to which cannot be
changed, here the membership is based on voluntary actions.
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One can apply for store membership card.
One can wait until the period of sales.
Those who are willing to jump small hurdles must be those with
more elastic demand!
Hanaki
Business Economics, L4
Product differentiation
The item, say a box of pasta, bought on the same day at the same
super market with or without membership card is the same
product.
But the same cloths bought in May and in June during the sales
may not be the same in terms of it fashionableness or timeliness.
Firms can sell basically the same good in different forms and
conditions at different prices to increase their revenues.
Example: Hardcover versus Softcover.
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Academic books (such as text books): Libraries and Institutional
buyers buy hard-cover edition, while individuals (esp. students) buy
soft-cover edition.
The price must be very different in order to differentiate them.
Hanaki
Business Economics, L4
Differentiating over time
One of the most common strategy used.
Bottom line: The impatient customers (those who cannot wait)
tend to have less elastic demand than patient customers (those
who can wait).
The hard-cover editions of popular books are released much
before the soft-cover editions.
Periodic sales
Price of telephone calls during the night and the weekend.
Price of electricity during the night and the weekend.
Hanaki
Business Economics, L4
A bit of remarks about telephone and electricity
Cost structures of telephone and electricity are such that it
depends on the peak load.
While the marginal cost of additional telephone call (or electricity
usage) is very low when the load on the system is not at its peak.
So by charging a lower price at the non-peak hours, firms try to
shift the demand to non-peak hours.
Why not apply this idea to usage of public transportation or
highways?
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Washington D.C. subway system: lower prices for off-peak hours.
Congestion tax in London: drivers have to pay to drive into the
central London in weekdays.
Hanaki
Business Economics, L4
Key to the success of these schemes
For the scheme to be successful, we need to prevent customers
with inelastic demand from buying the low priced goods.
Firms think hard about how to achieve this.
(May be a bit too extreme) Example
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A chemical and plastics firm has developed a material that can be
used for both dental filling and construction purposes.
Inelastic demand comes from dentistry.
Problem was how to prevent the dentists from buying lower priced
material aimed for construction companies.
The solution the firm came up with was to introduce a small amount
of an “impurity” into the material sold for construction purpose.
The “impurity” if introduced into someone’s mouth, it would slowly
poison the individual.
Hanaki
Business Economics, L4
Exercise
Doctors routinely ask patients about their occupation, employer, home
address, and scope of insurance coverage. How do the following
factors affect the scope for price discrimination in medical services?
Characteristics such as occupation and home address are quite
fixed.
It is physically impossible to transfer medical treatment from one
person to another.
Doctors treat patients on an individual basis.
Hanaki
Business Economics, L4