Wk6 DQ – Managerial Economics DQ (P) – Discussion Question 1 – (PDQ directed at upcoming PA) Graduate Level Prior to reading this DQ, please read the PA 2

Wk6 DQ – Managerial Economics DQ (P) – Discussion Question 1 – (PDQ directed at upcoming PA) Graduate Level

Prior to reading this DQ, please read the PA 2

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Wk6 DQ – Managerial Economics DQ (P) – Discussion Question 1 – (PDQ directed at upcoming PA) Graduate Level

Prior to reading this DQ, please read the PA 2 assignment and understand what the assignment is asking you to complete. Once you have an understanding of the PA 2 assignment, please continue to the paragraph below to complete DQ1.

Using the Library Information Resource Network (LIRN), JSTOR, or any other electronic journal database, research six (6) peer-reviewed articles that can be used to answer your upcoming PA 2 assignment. Your discussion should summarize the articles in such a way that it can justify any arguments you may present in your PA 2 assignment and should be different from the abstract. In addition to your researched peer-reviewed article, you must include an example of the article researched as it is applied by industry (company, business entity, and so forth).

Please note: This article summary should not be the only article researched for your PA 2 assignment. You may (and should) have several other articles researched to fully answer your PA 2 assignment. The concept of this DQ is to allow students to be proactive in the research necessary to complete this assignment. You may use your article summary, partially or in its entirety in your PA 2 assignment.

Important: Please ensure that your reference for the article is in correct APA format, as your reference in your discussion post. Depending on which electronic database you use, you should see a “Cite” selection for your article. In addition, there should be a variety of articles summarized and as such, students should have different articles summarized. Your summary MUST include ALL of the following in your DQ post (include every item in the bullet list below, or you will not receive full credit):

Do these in order:

– In correct APA format, write the Reference of the article.

– Clearly state what the article is about and its purpose.

– Describe how you will use it in your upcoming assignment.

– Repeat for a total of six (6) peer-reviewed sources.

Note:

1. Please find the related PowerPoint and textbook in the attachment.

2. Article List: (Needs to add one more peer-reviewed article)

Ali, B. J., & Anwar, G. (2021). Business strategy: The influence of Strategic Competitiveness on competitive advantage. International Journal of Electrical, Electronics and Computers, 6(2).

Galletta, S., Mazzù, S., & Naciti, V. (2021). Banks’ business strategy and environmental effectiveness: The monitoring role of the board of directors and the managerial incentives. Business Strategy and the Environment.

Ke, Y. (2021). Applications of Managerial Economics in Business Pricing Strategies. In E3S Web of Conferences (Vol. 235). EDP Sciences.

LESTARI, S. D., LEON, F. M., WIDYASTUTI, S., BRABO, N. A., & Putra, A. H. P. K. (2020). Antecedents and consequences of innovation and business strategy on performance and competitive advantage of SMEs. The Journal of Asian Finance, Economics, and Business, 7(6), 365-378.

Rahman, M. H., & Majumder, S. C. (2021). Relationship between developing manager and managerial economics: a theoretical overview. Independent Journal of Management & Production, 12(5), 1339-1356.

3. Please find the Course Learning Outcome list of this course in the attachment.

Textbook Information:

Baye, M. R., & Prince, J. T. (2017). Managerial economics and business strategy (9th ed.). McGraw-Hill Education

ISBN 9781259290619 Pricing Strategies for Firms with Market Power
© 2017 by McGraw-Hill Education. All Rights Reserved. Authorized only for instructor use in the classroom. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Chapter 11

Learning Objectives
Apply simple elasticity-based markup formulas to determine profit-maximizing prices in environments where a business enjoys market power, including monopoly, monopolistic competition, and Cournot oligopoly.
Formulate pricing strategies that permit firms to extract additional surplus from consumers—including price discrimination, two-part pricing, block pricing, and commodity bundling—and explain the conditions needed for each of these strategies to yield higher profits than standard pricing.
Formulate pricing strategies that enhance profits for special cost and demand structures—such as peak-load pricing, cross-subsidies, and transfer pricing—and explain the conditions needed for each strategy to work.
Explain how price-matching guarantees, brand loyalty programs, and randomized pricing strategies can be used to enhance profits in markets with intense price competition.

© 2017 by McGraw-Hill Education. All Rights Reserved.
2

Review of Basic Profit Maximization
Firms with market power face a downward-sloping demand.
Implication: there is a trade-off between selling many units at a low price and selling a few units at a high price.
Managers of firms with market power balance these competing forces by selecting the quantity that equates marginal revenue and marginal cost , and charging the maximum price that consumer will pay for this level of output.
© 2017 by McGraw-Hill Education. All Rights Reserved.
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Basic Pricing Strategies

3

Basic Profit Maximization In Action
Suppose the (inverse) demand for a firm’s product is given by and the cost function is . What is the profit-maximizing level of output and price for this firm?
Answer:
The marginal revenue function is: .
The marginal cost function is: .
Equating these two functions yields , so . The profit-maximizing price is .
© 2017 by McGraw-Hill Education. All Rights Reserved.
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Basic Pricing Strategies

4

Simple Pricing Rule: Monopoly and Monopolistic Competition
What if estimates of the demand and cost functions are not available?
Managers have a “crude” estimate of
marginal cost; the price paid to a supplier.
the price elasticity of demand, since it is typically available for a representative firm in an industry.
With this information, the monopoly and monopolistically competitive firm’s profit-maximizing price (markup) is computed from: MC =
, where .
So, set price such that: .

© 2017 by McGraw-Hill Education. All Rights Reserved.
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Basic Pricing Strategies

5

Simple Pricing Rule In Action: Problem
The manager of a convenience store competes in a monopolistically competitive market and buys cola from a supplier at a price of $1.25 per liter. The manager thinks that because there are several supermarkets nearby, the demand for cola sold at her store is slightly more elastic than the elasticity for the representative food store. Specifically, the elasticity of demand for cola sold by her store is . What price should the manager charge for a liter of cola to maximize profits?
© 2017 by McGraw-Hill Education. All Rights Reserved.
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Basic Pricing Strategies

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Simple Pricing Rule In Action: Answer
The marginal cost of cola to the firm is , or per liter, and the markup factor is .
The profit-maximizing pricing rule for a monopolistically competitive firm is:

, or about per liter.
© 2017 by McGraw-Hill Education. All Rights Reserved.
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Basic Pricing Strategies

7

Simple Pricing Rule for Cournot Oligopoly
When each of the firms operating in a Cournot oligopoly has identical cost structures and produces similar products, the simple profit-maximizing price (markup) in Cournot equilibrium is:

, where is the market elasticity of demand.
© 2017 by McGraw-Hill Education. All Rights Reserved.
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Basic Pricing Strategies

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Beyond the Single-Price-Per-Unit Model
In some markets, managers can enhance profits beyond those resulting from charging all consumers a single, per-unit price.
Models that yield greater profits fall into three categories:
Pricing strategies:
that extract surplus from consumers.
for special cost and demand structures.
in markets with intense price competition.
© 2017 by McGraw-Hill Education. All Rights Reserved.
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Strategies that Yield Even Greater Profits

9

Models that Extract Surplus from Consumers
Strategies for surplus extraction:
Price discrimination (first, second and third degrees)
Two-part pricing
Block pricing
Commodity bundling
Each strategy is appropriate for firms with various cost structures and degrees of market interdependence.

© 2017 by McGraw-Hill Education. All Rights Reserved.
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Strategies that Yield Even Greater Profits

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Surplus Extraction:
First-Degree Price Discrimination
Price discrimination is the practice of charging different prices to consumers for the same good or service.
First-degree price discrimination is the practice of charging each consumer the maximum price he or she would be willing to pay for each unit of the good purchased.
Implication: the firm extracts all surplus from consumers and earns the highest possible profit.
Problem: managers rarely know each consumers’ maximum willingness to pay for each unit of the product.
© 2017 by McGraw-Hill Education. All Rights Reserved.
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Strategies that Yield Even Greater Profits

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First-Degree Price Discrimination
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Strategies that Yield Even Greater Profits
Price
Quantity
Demand
MC

Firm profit under first-degree
price discrimination

12

Surplus Extraction:
Second-Degree Price Discrimination
Second-degree price discrimination is the practice of posting a discrete schedule of declining prices for different ranges of quantity.
Implication: firm extracts some surplus from consumers without needing to know the identity of various consumers’ demand.
© 2017 by McGraw-Hill Education. All Rights Reserved.
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Strategies that Yield Even Greater Profits

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Second-Degree Price Discrimination
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Strategies that Yield Even Greater Profits
Price
Quantity
Demand
MC

Contribution to profits under
second-degree price discrimination

14

Surplus Extraction:
Third-Degree Price Discrimination
Third-degree price discrimination is the practice of charging different prices based on systematic differences in demand across demographic consumer groups.
Implication: marginal revenue will be different for each group. That is, if there are two groups, , for example.

© 2017 by McGraw-Hill Education. All Rights Reserved.
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Strategies that Yield Even Greater Profits

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Surplus Extraction: Third-Degree
Price Discrimination Rule
To maximize profits, a firm with market power produces the output at which the marginal revenue (left-hand side of the following equations) to each group equals marginal cost.

© 2017 by McGraw-Hill Education. All Rights Reserved.
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Strategies that Yield Even Greater Profits

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Third-Degree
Price Discrimination Rule In Action:
You are the manager of a pizzeria that produces at a marginal cost of $6 per pizza. The pizzeria is a local monopoly near campus. During the day, only students eat at your restaurant. In the evening, while students are studying, faculty members eat there. If students have an elasticity of demand for pizza of and faculty has an elasticity of demand of , what should your pricing policy be to maximize profits?
© 2017 by McGraw-Hill Education. All Rights Reserved.
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Strategies that Yield Even Greater Profits

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Third-Degree
Price Discrimination Rule In Action:
Assuming faculty would be unwilling to purchase cold pizzas from students, the conditions for effective third-degree price discrimination hold. It will be profitable to charge a “lunch menu” price and a “dinner menu” price. These prices are determined as follows:

Solving these equations yield, and .

© 2017 by McGraw-Hill Education. All Rights Reserved.
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Strategies that Yield Even Greater Profits

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Surplus Extraction: Two-Part Pricing
Two-part pricing is a pricing strategy whereby a firm with market power charges a fixed fee for the right to purchase its goods, plus a per-unit charge for each unit purchased.

© 2017 by McGraw-Hill Education. All Rights Reserved.
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Strategies that Yield Even Greater Profits

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Two-Part Pricing
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Strategies that Yield Even Greater Profits
Price
Quantity
Demand
MC = AC

Fixed fee = $32 = profits
Consumer surplus = $0

Per-unit fee = $2

20

Surplus Extraction: Block Pricing
Block pricing is a pricing strategy in which identical products are packaged together in order to enhance profits by forcing customers to make an all-or-none decision to purchase.
The profit-maximizing price on a package is the total value the consumer receives for the package.

© 2017 by McGraw-Hill Education. All Rights Reserved.
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Strategies that Yield Even Greater Profits

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Block Pricing
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Strategies that Yield Even Greater Profits
Price
Quantity
Demand
MC = AC

Profit with block pricing = $32

Price charged for a block of 8 units = $48

22

Surplus Extraction: Commodity Bundling
Commodity bundling is the practice of bundling several different products together and selling them at a single “bundle price.”
Key assumption: Consumers differ with respect to the amounts they are willing to pay for multiple products sold by a firm.
Managers cannot observe different consumers’ valuations.

© 2017 by McGraw-Hill Education. All Rights Reserved.
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Strategies that Yield Even Greater Profits

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Pricing Strategies for Special Cost and Demand Structures: Peak-Load Pricing
Peak-load pricing is a pricing strategy in which higher prices are charged during peak hours than during off-peak hours.

© 2017 by McGraw-Hill Education. All Rights Reserved.
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Strategies that Yield Even Greater Profits

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Special Demand and Costs:
Peak-Load Pricing
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Strategies that Yield Even Greater Profits
Price
Quantity
Demand High
MC

MR High
Demand Low
MR Low

25

Special Demand and Costs:
Cross-Subsidies
Cross-subsidy is a pricing strategy in which profits gained from the sale of one product are used to subsidize sales of a related product.
Cross-Subsidization Principle:
Whenever the demands for two products produced by a firm are interrelated through costs or demand, the firm may enhance profits by cross-subsidization: selling one product at or below cost and the other product above cost.

© 2017 by McGraw-Hill Education. All Rights Reserved.
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Strategies that Yield Even Greater Profits

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Special Demand and Costs:
Transfer Pricing
Transfer pricing is a pricing strategy in which a firm optimally sets the internal price at which an upstream division sells an input to a downstream division.
Important since most division managers are provided an incentive to maximize their own division’s profits.
Transfer pricing aligns division manager’s incentives with that of the overall firm, and increases overall firm’s profit.

© 2017 by McGraw-Hill Education. All Rights Reserved.
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Strategies that Yield Even Greater Profits

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Special Demand and Costs:
Double Marginalization
Consider a large firm with two divisions:
upstream division is the sole provider of a key input.
downstream division uses the input produced by the upstream division to produce the final output.
Upstream division has market power and incentive to maximize divisional profits leads managers to produce where .
Implication: .
A similar situation exists for the downstream division; profit-maximization leads to .
Both divisions mark price up over marginal cost resulting in a phenomenon called double marginalization.

© 2017 by McGraw-Hill Education. All Rights Reserved.
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Strategies that Yield Even Greater Profits

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Special Demand and Costs:
Transfer Pricing Rule
Transfer pricing is used to overcome double marginalization.
A transfer pricing rule sets the internal price at which an upstream division sells inputs to a downstream division in order to maximize the overall firm profits.
Require the upstream division to produce such that its marginal cost, , equals the net marginal revenue to the downstream division:

© 2017 by McGraw-Hill Education. All Rights Reserved.
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Strategies that Yield Even Greater Profits

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Intense Price Competition:
Price Matching
Price matching is a strategy in which a firm advertises a price and a promise to match any lower price offered by a competitor.
Used to mitigate the stark outcome associated with firms competing in a homogeneous-product, Bertrand oligopoly.
Outcome: If all firms in the market adopt a price matching policy, all firms can set the monopoly price and earn monopoly profits; instead of the zero profits it would earn in the usual one-shot Bertrand oligopoly.
Potential issues:
Dealing with false consumer claims of low prices.
Competitor’s with lower cost structures.
© 2017 by McGraw-Hill Education. All Rights Reserved.
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Strategies that Yield Even Greater Profits

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Intense Price Competition:
Inducing Brand Loyalty
Brand loyal customers continue to buy a firm’s product even if another firm offers a (slightly) better price.
Strategy used to mitigate the tension of Bertrand competition.
Methods for inducing brand loyalty.
Advertising campaigns.
“Frequent-buyer” programs.

© 2017 by McGraw-Hill Education. All Rights Reserved.
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Strategies that Yield Even Greater Profits

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Intense Price Competition:
Randomized Pricing
Randomized pricing is a strategy in which a firm intentionally varies its price in an attempt to “hide” price information from consumers and rivals.
Benefits of randomized pricing to firms:
Consumers cannot learn from experience which firm charges the lowest price in the market.
Reduces the ability of rival firms to undercut a firm’s price.
Not always profitable.

© 2017 by McGraw-Hill Education. All Rights Reserved.
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