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Chapter 11: Q11. (page 413)

Look again at Figure 11.12 (p. 434), which shows the reservation prices of three consumers for two goods.

Assuming that marginal production cost is zero for both goods, can the producer make the most money by selling the goods separately, by using pure bundling, or by using mixed bundling? What prices should be charged?

Short Answer

Expert verified

The producer will make the most of the money by using the strategy of mixed bundling for selling goods.

The producer should charge $6 for Good 1 from Consumer A, $8.55 from Consumer B, and a bundle price of $20 for both goods from Consumer C.

Step by step solution

01

Step 1. Select the best pricing policy for the producer.

  • Separate pricing policy:Under this pricing policy, the producer charges separate prices for each good from the consumers based upon their maximum reservation prices. The producer will charge the price based upon the customer’s maximum reservation prices for good. Customer A’s reservation price for Good 1 is higher than Good 2. Customer B’s reservation price for Good 2 is higher than Good 2, and Customer C’s reservation price for both the good is the same.

Thus, under this policy, the producer can earn maximum profit by charging $6 for Good 1 from A, $8.25 for Good 2 from B, and $10 for either of the goods from C. Since the marginal cost is assumed zero, the total profit would be (6+8.25+10) = $22.25

  • Pure bundling:Under this pricing policy, the producers sell both the goods as an individual product and charge a combined price for both the goods. If the producer applies this pricing strategy, it will bundle both the goods into a single package. The maximum price the producer can charge is $20 for the package.

At this price, only Customer C would be able to purchase the package. Hence the total profit of the firm will be $20.

  • Mixed bundling:When a producer uses both the pricing policy (selling goods separately and pure bundling) to charge different consumers, it comes under a mixed bundling pricing policy. If the producer applies this pricing strategy, they will apply a separate pricing policy for Customer A and Customer B and sell the package of both the goods to Customer C.

Under this policy, the producer will charge $6 for Good 1 from A, $8.25 for Good 2 from B, and a package price of $14.25 from Customer C. The total profit would be the sum of all three, (6+8.25+14.25) = $28.5.

On comparing all the three possible pricing strategies, it is clear that the mixed pricing policy yields the maximum profit. Hence, the producer will earn most of the money by applying mixed pricing policy.

02

Step 2. Determining the prices that the producer should charge from consumers

The producer should charge a price equal to the maximum reservation prices of the customers for that good or combination of goods (package). Since the producer applies a mixed pricing strategy, they will apply a ‘separate pricing policy’ on Consumers A and B and bundling price from Consumer C.

Customer A’s reservation price for Good 2 is higher than Good 1, and Customer B’s reservation price for Good 1 is higher than Good 2. Thus, the producer will set the price for Good 1 at $6 and Good 2 at $8.25. In this way, the producer can earn the maximum possible return on both the goods.

The producer will offer a package price for both goods to Customer C. Customer C’s reservation price for each good is $10; they will buy the package of both the goods. The maximum price the producer will charge on the package will be the price sum of both the goods. Thus, Customer C will pay $14.25 (6+8.25) for the package.

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Most popular questions from this chapter

Some years ago, an article appeared in the New York Times about IBM’s pricing policy. The previous day,IBM had announced major price cuts on most of itssmall and medium-sized computers. The article said:

IBM probably has no choice but to cut prices periodicallyto get its customers to purchase moreand lease less. If they succeed, this could makelife more difficult for IBM’s major competitors.Outright purchases of computers are needed for ever larger IBM revenues and profits, says Morgan Stanley’s Ulric Weil in his new book, InformationSystems in the 80’s. Mr. Weil declares that IBM cannot revert to an emphasis on leasing.

a. Provide a brief but clear argument in support of the claim that IBM should try “to get its customers to purchase more and lease less.”

b. Provide a brief but clear argument against this claim.

c. What factors determine whether leasing or selling is preferable for a company like IBM? Explain briefly.

You are selling two goods, 1 and 2, to a market consisting of three consumers with reservation prices as follows:

RESERVATION PRICE (\()

CONSUMER FOR 1 FOR 2

A 20 100

B 60 60

C 100 20

The unit cost of each product is \)30.

a. Compute the optimal prices and profits for (i) selling the goods separately, (ii) pure bundling, and (iii) mixed bundling.

b. Which strategy would be most profitable? Why?

Your firm produces two products, the demands for which are independent. Both products are produced at zero marginal cost. You face four consumers (or groups of consumers) with the following reservation prices:

CONSUMER GOOD 1(\() GOOD 2(\))

A 25 100

B 40 80

C 80 40

D 100 25

a. Consider three alternative pricing strategies: (i) selling the goods separately; (ii) pure bundling; (iii) mixed bundling. For each strategy, determine the optimal prices to be charged and the resulting profits. Which strategy would be best?

b. Now suppose that the production of each good entails a marginal cost of $30. How does this information change your answers to (a)? Why is the optimal strategy now different?

As the owner of the only tennis club in an isolated wealthy community, you must decide on membership dues and fees for court time. There are two types of tennis players. “Serious” players have demand

Q1 - 10 - P

where Q1 is court hours per week and P is the fee per hour for each individual player. There are also “occasional” players with demand

Q2 = 4 - 0.25P

Assume that there are 1000 players of each type. Because you have plenty of courts, the marginal cost of court time is zero. You have fixed costs of $10,000 per week. Serious and occasional players look alike, so you must charge them the same prices.

  1. Suppose that to maintain a “professional” atmosphere, you want to limit membership to serious players. How should you set the annual membership dues and court fees (assume 52 weeks per year) to maximize profits, keeping in mind the constraint that only serious players choose to join? What would profits be (per week)?
  2. A friend tells you that you could make greater profits by encouraging both types of players to join. Is your friend right? What annual dues and court fees would maximize weekly profits? What would these profits be?
  3. Suppose that over the years, young, upwardly mobile professionals move to your community, all of whom are serious players. You believe there are now 3000 serious players and 1000 occasional players. Would it still be profitable to cater to the occasional player? What would be the profit-maximizing annual dues and court fees? What would profits be per week?

In Example 11.1 (page 422), we saw how producers of processed foods and related consumer goods use coupons as a means of price discrimination. Although coupons are widely used in the United States, that is not the case in other countries. In Germany, coupons are illegal.

  1. Does prohibiting the use of coupons in Germany make German consumers better off or worse off?

  2. Does prohibiting the use of coupons make German producers better off or worse off?
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