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ECON214 (Fall 2010)
24. 11. 2010 (Tutorial 10)
Chapter 11 Pricing Strategies for Firms with Market Power
Basic pricing strategies
Firms maximizes profits by equating MR and MC
Firms can use information about elasticities to determine the profit-maximizing markup
used to set product prices
Relation between MR and elasticity of demand
firm s revenue
where
(1) Pricing rule for Monopoly and Monopolistic Competition
The optimal price is a simple markup over MC
The more elastic the demand, the lower markup. The less elastic the demand, the higher
the markup
A firm with higher MC will charge a higher profit-maximizing price
Example:
A convenient store competes in a monopolistically competitive market and buys soft drinks
from a supplier a price of $1.25. The elasticity of demand for the store is 4. What is the
profit maximizing price of soft drinks? What is the profit-maximizing price if the store
competes in a perfectly competitive market?
If the store competes in a monopolistically competitive market, then,
If the store competes in a perfectly competitive market, . The markup factor
approaches 1, and P = MC = 1.25
Note: the Markup factor in a monopolistically competitive market is larger (which is 4/3 > 1)
(2) Pricing rule for Cournot Oligopoly
Assume there are N identical firms in a Cournot oligopoly selling homogeneous product
EF = NEM (elasticity of demand for a firm is N times of the market elasticity of demand)
Profit maximizing price for a firm is
The more elastic the market demand, the closer the profit-maximizing price to MC
(smaller markup factor)
The larger the number of firms, the closer the profit-maximizing price to MC (smaller
markup factor)
The higher the MC, the higher the profit-maximizing price
Example:
Suppose 3 firms compete in a homogeneous-product Cournot industry. The market elasticity
of demand for the product is 2, and each firm’s MC is $50. What is the profit-maximizing
equilibrium price?
The profit-maximizing price:
Pricing strategies for greater profits (by extracting surplus from consumers)
(1) Price discrimination
The practice of charging different prices to consumers for the same good or service
Price discrimination works only if there is no resell in the market and firms have perfect/
some information about the consumers depending on the type of price discrimination it
implements
(a) First degree (Perfect) price discrimination
The practice of charging each consumer the maximum amount he would be willing to pay
for each unit of good purchased
Firms extract all surplus from consumers and earn the highest possible profits.
It works if firms have perfect information on consumers’ willingness to pay
(b) Second degree price discrimination
The practice of posting a discrete schedule of declining prices for different ranges of
quantities
