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Lecture 8

MGM230H5 Lecture Notes - Lecture 8: Forego, Complementary Good, Marginal Revenue

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Jeff Landry

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Lecture 8
Price – amount of money charged for a product or service, or the sum of the values that
consumers exchange for the benefits of having or using the product or service
How do firms set prices?
oWhat is firm’s objective function?
oAccordingly, what is the optimization problem that the firm is solving
oSuppose goal is to max profits
If not from a single product, may be maxing total present and future
profits for all products
May choose to max sales, revenue, market share, growth
oFirm may forego profits today to do business in an environmentally-friendly or
ethical manner
oTo max profits, first consider cost structure, consumer demand, competitors
Customer perceptions of value
oValue-based pricing uses buyers perceptions of value, not sellers costs as key to
oValue based pricing is customer driven, cost isn’t considered
oCost-based pricing is product driven
Cost based pricing; design, determine product costs, set price based on cost, convince
buyers of products value
Value based pricing; assess customer needs and value perception, set target price to
match perceived value, determine costs that can incur, design product to deliver desired
value at target price
Cost-plus pricing – adds standard mark up to cost of product
oAdv. – sellers are certain about costs, prices are similar in an industry, price
competition is minimized, consumers feel it’s fair
oDis.adv. – ignores demand and competitors prices
Monopoly pricing – reflects first 2 factors
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oFirms incorporate value and cost in determining prices
oOne seller, many buyers, no competition
oFace downward-sloping demand curves
Key tradeoff between price and quantity sold
osuppose market demand, monopolist charges a price P to sell quantity Q, P = a-
a, b > 0
the more you want to sell, lower price must be
orevenue, R = PQ = (a-bQ)Q = aQ-bQ2
omarginal revenue, MR = a-2bQ
marginal revenue is lower than price
osuppose per-unit marginal cost is constant: MC = c
osell up to the quantity where MR = MC
Q* = (a-c)/2b, P*= (a+c)/2
oOptimal price and quantity both depend on the price elasticity of demand and the
oMonopolists optimal price increases for
Increase in demand
Increase in cost
Decrease in elasticity of demand
oProfit = Revenue – Cost = PQ –cQ
Price elasticity of demand (PED)
o= %change in quantity demanded/%change in price
o(change in Q)/(original Q) / (change in P)/(original P)
Factors that reduce price sensitivity
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