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Chapter 8

Chapter 8 EC260.docx

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Karen Huff

EC260 Chapter 8 – Managerial Use of Price Discrimination Week 8 -Price discrimination is common across many markets and products -Managers try to identify submarket on the basis of an individual’s price elasticity o demand Motivation for Price Discrimination -Consumer surplus Price Discrimination -Price discrimination – when the same product is sold at more than one price First-Degree Price Discrimination -Ex. The auto dealer -Second degree – Ex. Airline -Third degree – Ex. Candy firm -If managers could perfectly price discriminate (first-degree price discrimination), they would capture all consumer surplus an turn it into producer surplus -First-degree discrimination lets managers expand sales -The potential for additional profit gets creative managers thinking about pricing strategies to capture it -As a manager you always want to find ways to use first-degree price discrimination -This strategy allows managers to charge each consumer his or her reservation price -Managers sell to a consumer as long as the reservation price exceeds the marginal cost of production -In essence, using first-degree price discrimination, the manager gets to bake the cake and eat it too -Under first-degree, consumer surplus is zero -Managers usually have a small number of buyers Second-Degree Price Discrimination -Most common in utility pricing -Ex Gas, water, electricity, etc. -The manager, by charging different prices for various amounts of the commodity, increases revenues and profit -By charging different prices, managers increase profit relative to a single-price strategy Third-Degree Price Discrimination -The most common kind -Managers identify individuals with similar traits and group them together – managers then appeal to the group -Ex. Students -If managers want to use a third-degree strategy, they must decide how much output to allocate to each class of buyer and at what price -Managers will maximize profit by allocating the total output so that the marginal revenue in one class is equal to the marginal revenue in the other -Managers can increase profit by allocating one less unit of output to the second class and one more unit to the first class -If a manager chooses total output, the manager will optimize profit when the marginal cost of the entire output is equal to the common value of the marginal revenu
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