How Price Determined?  MARGINAL PRICING There are two conditions:  MC = MR  Slope of MC > Slope of MR

How Price is Determined?  Consider the Demand Function Q = 10 – 2P (1)‏ TC = Q (2)‏ MC =  TC/  Q = 2

How Price is Determined? MR =  TR/  Q TR = P.Q from (1)‏ TR= (5 – 0.5 Q) Q MR= 5 – Q Equilibrium, MC = MR 5 - Q = 2; Q = 3 Substituting Q in (1)‏ P = 3.5

CS How Price is Determined? DD Quantity Price MC MR

Pricing Practices  Mark-Up pricing or Cost Plus Pricing  Price = Cost + Mark-up  P = AVC + GPM = AC  GPM = AFC + NPM  Price = Cost (1 + Mark-up) ‏  Cost = Rs. 100;  Mark-up = 25%  Rs = 125  Mark-up is the difference between price and Cost

Mark-up pricing  Whether this price optimal?  Depends on the value of price elasticity  Cost = 100  ep = -1.8  Mark-up =  Optimal Price = Rs.100 ( ) = Rs. 2.25

Transfer Pricing  Pricing of intermediate products sold by one division of a firm and purchased by another division of the same firm  Made necessary by decentralization and the creation of semiautonomous profit centers within firms

Transfer Pricing  Why?  the price paid by a division affects the output of each division and, therefore, the output of the entire enterprise.  transfer prices affect the profitability of the divisions involved in the transfer of the intermediate products, and, as such, they serve as inceptives and rewards for the efficient operation of the various divisions of the enterprise.  Too-low transfer prices artificially reduce the profitability of the producing division and artificially increase the profitability of the purchasing division, and these can undermine the morale of managers, officers, and workers of the former because salary increases and bonuses, and sometimes even their jobs, depend on the profitability of the division.

Transfer Pricing  Geared towards maximising total company profit  Final pricing may be dictated centrally from the top corporation

Alternate Ways of Pricing  Bundling Pricing oFree with bundle of products –Internet explorer free with windows –Two for the price of one –Power steering with new cars  Block Pricing oSingle uniform pricing –Club membership free  Two Part Pricing oPricing in two stages –Membership fee and then user fee –Per unit fee = MC + fixed equal to consumers surplus  Peak Load Pricing oPricing when high demand –Telephone Tarriff

Alternate Ways of Pricing  Tie – in – Sales Pricing Bundling Required Tie –in – Sales (required to buy by technology) ‏ - Windows with HP computers  Predatory Pricing oPrice < or = minimum of AC oEntry preventing  Skimming pricing oFrom higher price to lower oFor new products before competition starts  Penetrating Pricing oFrom lower price to high –Consumer Durables

Alternate Ways of Pricing  Prestige Pricing  Prestige that ownership bestows on the buyer  Demand high at higher price

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