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Applied Marketing.doc

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Administrative Studies
Course Code
ADMS 3220

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Pricing with market power: market segmentation, price discrimination Market segmentation, price discrimination - The simple one-price monopoly outcome leaves some untapped areas of customer surplus value (consumer surplus) (see PRICE DISCRIMINATION AND MARKET SEGMENTATION): -- There are customers with even higher willingnesses to pay who "only" pay the monopoly price -- There are potential customers with willingnesses to pay that are below the monopoly price but above the seller's marginal costs - So, the monopolist (or any firm that faces a negatively sloped demand curve and thus has some discretion with respect to price) would like to charge different prices to different customers or groups of customers, in order to capture more of that untapped surplus value (consumer surplus) - In order to succeed in this market segmentation or price discrimination, four things have to hold: -- There have to be different willingnesses to pay -- There has to be some way to identify the different customers (or groups) with the different willingnesses to pay (or some mechanism that will cause them to identify themselves) -- Arbitrage must be prevented (i.e., those who buy at the low price cannot be able to resell to those who would otherwise buy from the firm at a higher price); the groups or segments must be kept separated -- The seller has to be prepared to deal with the potential unhappiness of the buyers who buy at relatively high prices and who know that there are other buyers who buy at lower prices - Services are often a ripe place for segmentation, since resale of services is often virtually impossible (e.g., a haircut or medical services or education) or is possible but difficult (e.g., electricity, telephone service); also, for many services comparisons among buyers are difficult; the seller can claim that the "true" service provided to the different buyers (at different prices) are different (see “Variable Pricing and the New York Mets” mini-case) "Perfect" or complete price discrimination (1st degree): - This involves setting a separate price for each demander at each point on the demand curve facing the firm -- This is hard to do, because of the problems of identifying which customer has which willingness to pay -- Versions of this phenomenon arise in college education (different levels of scholarships [which are discounts off the "list price" of tuition] for different individuals); a knowledgeable salesperson facing buyers in bargaining situations (e.g., for a new or used car; a street vendor); doctors (70 years ago, especially in rural areas) charging different fees to different patients; lawyers; consultants and contractors Direct segment discrimination (3rd degree price discrimination): - Suppose that the seller can identify two (or more) separate groups of customers with different demand elasticities -- Then the seller should find the MC=MR output point for each group and charge the resulting (different) price to each group: higher price to the less elastic group; lower price to the more elastic group (the identical item being sold to both groups) -- Important that the seller prevent arbitrage or "masquerading" -- Examples: student or senior citizen discounts for goods or services, such as movie theatre admissions; different prices for goods (such as pharmaceuticals) to different geographic areas (with transportation costs preventing re-shipments and arbitrage); different prices for pharmaceuticals sold to hospitals, managed care programs versus individual pharmacies; different prices for local telephone service or electricity service for residential versus commercial customers; different prices for academic/scientific journals that are charged to individuals and to libraries; different prices for automobile sales (fleet buyers versus individual buyers); different wholesale prices for Heinz k
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