ECON 325 - Study Questions

READ:  These questions are not designed to take the place of studying your notes and the reading assignments.  Do not e-mail me and ask me to answer all or some of these questions for you.  If you have missed class, it is your responsibility to get the notes from another student.  Once you have answered these questions yourself, if you are unsure of any of your answers, let me know and I will tell you if you are correct or not.  Don't be afraid to ask me questions, I just want you to try to answer the questions yourself first.

Topic:  Subjective Value and Demand - Review of Basics

1. What assumptions do economists make about human action?

2. What are the two basic problems that economists address and why do they exist?

3. What does opportunity cost mean?  Can you apply it?

Topic:  Where Do Market Prices Come From:  Subjective Value and Demand

1. Who, after all is said and done, determines prices in markets?
2. Explain each step of Menger's value theory (of a good).
3. Related to this - what does "causal connection" mean - and give an example.
4. When does Menger's value theory lead to an "economic good'?
5. Could a non-scarce good have value?  Would it have exchange value or a price?  Explain.
6. What is an "imaginary good" to Menger?  Give an example.
7. Why would some economists say that imaginary goods don't really exist since all that matters is the subjective perception of the consumer?  Explain.
8. Explain Menger's ranking system for goods and ends.  Why would one good start with an end value of 10, while another would start with an end value of 9. Give an example (with any assumptions necessary).
9. Using Menger's ranking system theory -- explain diminishing marginal utility (or value). 
10. What was the diamond/water paradox?
11. How was it answered by Menger/Jevons/Walras - generally speaking - what two ideas enabled the paradox to be solved?
12. What is the "imputation theory" with respect to inputs in a production process?  Explain.
13. Explain why it is the marginal utility of a good that is bought that influences the price of a good - not the total utility.
14. Explain a pricing strategy that would use the theory of diminishing marginal utility.
15. Relate opportunity cost to the subjective ends of people.  If a consumer buys x over y, what is the opportunity cost to the consumer?
16. Using the theory of diminishing marginal utility (as per Menger), derive a demand curve (graphically).

Topic:  Subjective Value and Supply

1. Most analyses of producer supply discusses the objective cost of production.  What does that mean?
2. However, to determine how those costs come about - what has to be analyzed?
3. Be able to explain the law of increasing marginal opportunity cost.
4. Relate this law to the upward slope on the supply curve -- that is, why must the price of a good increase as quantity supplied increases?
5. How does this theory of supply relate back to consumer values?  Make sure you can explain.
6. What is the difference between the ability to supply and the willingness to supply?  Explain why both are necessary for supply to take place.
7. How might consumers gain knowledge of the causal connection of a good?  Examples?
8. How does the producer gain knowledge in markets when trying to determine what consumers value?
9. In relation to this - discuss the role of inventory costs (what are they - examples); surpluses (show on a graph and define); shortages (show on a graph and define); market clearing price (what does this mean)?
10. Discuss the relationship between prices and resource allocation in markets.
11. What does it mean for a price to be "distorted" in some way?
12. What does misallocation of resources mean (basically, by definition)?
13. Be able to determine a price change using the supply and demand model.

Topic:  Review of Price Elasticity

1. What does elasticity mean generally speaking?
2. What is the price elasticity of demand (PED)?  What is the concept?  What is the formula?
3. Be able to determine the price elasticity of demand from % changes.
4. What does an elasticity coefficient tell us?  With every _____% change in the price of a good, there is a ____% change in demand.
5. What does it mean if the PED coefficient is greater than one?  equal to one?  less than one?
6. Elasticity coefficients are always determined by the absolute value - so what does the sign (- or +) actually tell us?
7. What are the determinants of the price elasticity of demand that we discussed in class (we discussed four of them).  Be able to explain the theories, provide examples of each, and use them in applications.
8. What are "switching costs" as it relates to substitute goods?  Examples?
9. What is the difference between the ability to demand and willingness to demand?  Explain why both are necessary for demand to take place.
10. Some individual demand curves could have a range of prices where demand is perfectly inelastic - what does that mean?  Graph?  Elasticity coefficient would be ___? 
11. Why is percent inelastic market demand curves not likely?  Relatively inelastic market demand curves are more realistic.  Explain.  Graph?
12. Would an individual's demand curve be perfectly elastic?  What does that mean?  Graph?  Elasticity coefficient would be ___? 
13. What about a market demand curve that is relatively elastic?  Graph?
14. How is total revenue (TR) calculated?
15. Relate the price elasticity of demand to TR. 
16. If a good is elastic (ceteris paribus), with a drop in price, what will happen to TR?  Explain?  An increase in price, what will happen to TR?  Explain.
17. If a good is inelastic (ceteris paribus), with a drop in price, what will happen to TR?  Explain?  An increase in price, what will happen to TR?  Explain.
18. What is the cross price elasticity of demand?  Concept?  Formula?
19. What factors influence cross price elasticity of demand?  What does the coefficient sign tell us?
20. How would switching costs play a role in cross price elasticity of demand?
21. What price strategy applications might there be when using the information of cross price elasticity of demand?

EXAM ONE STOPS HERE

EXAM TWO STARTS HERE

Topic:  An Overview of the Art of Pricing and General Pricing Ideas

1. Graphically illustrate the range of prices that sellers are "typically" dealing with when deciding what price to charge.  Explain in words too.
2. Generally speaking, what are the three ways by which prices are set or determined?
3. Why might a good pricing strategy increase profit more than cutting costs or increasing sales volume with a non-price strategy?
4. What are the two most conventional ways of setting or determining prices?
5. Explain how to calculate a price using cost-plus pricing. 
6. Why is cost-plus pricing so popular?
7. What are some drawbacks to cost-plus pricing?  What do you think is the biggest draw-back and why?
8. Know the difference between direct costs and indirect costs as used in cost-plus pricing.
9. What is competitive pricing or market based pricing?
10. Why is competitive pricing so popular?
11. What are some drawbacks to competitive pricing? 
12. What is a market share?
13. What causes a downward price spiral?
14. Why is it difficult to define a market price?
15. Two more popular or conventional pricing methods are pricing to close a deal and pricing to gain market share.  Explain both.
16. Why is pricing to close a deal popular?
17. What are some drawbacks to pricing to close a deal?
18. Why is pricing to gain market share popular?
19. What are some drawbacks to pricing to gain market share?
20. Why is making more sales not necessarily a good goal to have?  What should a firm's pricing strategy be striving to achieve?
21. What questions should be asked when thinking about creating value for customers?
22. Be familiar with Holden and Burton's Ten Rules to Pricing Confidence.  What do they mean by being "confident" in your pricing decision?

Topic:  Behavioral Economics and the Psychology of Pricing

            Background

1. How is a rational act defined by mainstream economics?
2. How do behavioral economists differ from mainstream economics in terms of rationality? 
3. How do behavioral economists differ from mainstream economics in terms of the action of a consumer buying something? 
4. Explain two reasons that behavioral economists might say that someone is acting in an irrational way.
5. How might you respond to those reasons if you disagreed (regarding #4 above)?

            Prestige Pricing and Price as an Indicator of Quality

1. Explain the prestige effect of price. What is the pricing theory behind it?
2. How did Thorsten Veblen discuss the snob effect or conspicuous consumption.  Relate this to the prestige effect of price.
3. Why do some believe that the prestige effect leads to an upward sloping demand curve?
4. How do most economists respond to that idea (of an upward sloping demand curve)?  Graph?
5. If a firm is trying to convince consumers that they produce a higher quality product by using a pricing strategy (prestige pricing) - how might they go about doing that?  Assume they have been in the market for a while.
6. Under what circumstances (that we discussed) do consumers judge quality by price?
7. What are some psychological explanations as to why consumers might judge quality by price?
8. What is the placebo effect of price?  How does it relate to judging quality by price?
9. Assume a firm is using prestige pricing or using price to signal quality - why/how does that strategy defuse using price as a competitive weapon?

            Price Anchoring

1. What is price anchoring or the "first impressions effect"?  Provide an example. 
2. Price anchoring is especially useful when the consumer knows nothing about the product.  Why?
3. Psychologically, why might price anchoring work?
4. How long, according to mainstream economic theory, will a consumer search for information about a product (theoretically)?  Graph?
5. Explain a downside to price anchoring.
6. How might a firm go about applying price anchoring?

           Decoy Pricing

1. What is decoy pricing?  What is it trying to accomplish?
2. What are some psychological explanations as to why decoy pricing might work (don't worry about the diminishing marginal utility explanation given in the reading).
3. Explain two ways of using decoy pricing.  Examples.

            Price Thresholds and Odd Pricing

1. What is a price threshold?  How does it relate to the economics term reservation price?
2. What is the idea that if there is a threshold - there might be a kink (or more) in a demand curve?  Explain.  Graph?
3. Provide two arguments as to why odd pricing (such as using $3.99) will work.
4. What is the obvious problem with setting a price as close to the threshold as possible?
5. Do all studies indicate the odd pricing works?
6. What are some problems with using odd pricing (such as using $3.99)?
7. We looked at one study that showed that a different pricing strategy out-sold odd pricing - what was it?
8. Then - what out-sold that policy (from above)?
9. Does font size seem to matter when listing a price?  Explain.

            Prospect Theory

1. What does prospect theory suggest?  What does it say about positive and negative utility?
2. What is the endowment effect?  Relate to prospect theory.
3. What does prospect theory say about paying with a credit card vs. cash?  Pricing strategy that relates to this?
4. What are sunk costs?  What does prospect theory say about the psychological aspects of sunk costs?
5. What is the reminder effect of cash?
6. What is a cash back pricing scheme?  Relate to prospect theory.
7. What is a moon price?
8. Two ways of using moon pricing are price discrimination and providing a discount.  Explain.
9. What is meant by a price structure or price metric?
10. Why does prospect theory say that a lump sum payment by consumers is better than payments over time?
11. What might be some exceptions to this?  Explain.

EXAM TWO STOPS HERE

EXAM THREE STARTS HERE (Moved to Wednesday, Nov. 9)

Topic:  Price Structures

1. What is a price structure?
2. What does it mean to "price-segment" the market?
3. When "rethinking the unit" what two things should you keep in mind?
4. What does demand heterogeneity mean?
5. We discussed four ways of redefining the unit.  What are they?
6. What is an add-on?  Example.
7. What is the concept of "versions"?  Example.
8. What are bundles?  Example.  What is a difference between an add-on and a bundle?
9. What is multi-part pricing?
10. What is a two-part tariff?  What is the basic strategy behind a two-part tariff?
11. When will the fee be priced relatively high and the metered component of a two-part tariff be priced relatively low?  And vice versa?
12. Why does the use of a two-part tariff require products that cannot be easily resold or stored for later use?  Explain.
13. What is a block tariff?  Graph.  Example.
14. What is an inclined tariff?  Graph.  Example.
15. What is a tying arrangement?  Example.  How is it similar to a two-part tariff?  How is it different from a two-part tariff?
16. What is the overall goal (besides profit of course) of implementing a tying arrangement?
17. How might firms stop consumers from going elsewhere for the consumable good when using a tying arrangement - in other words - what are some switching barriers firms might use?

Topic:  Price Structures cont. - Price Discrimination

1. What are the two different ways to practice price discrimination?
2. What is consumer surplus?  Producer surplus?  Graph.
3. How does price discrimination relate to consumer surplus?
4. Generally speaking - what are the conditions for price discrimination to work?
5. What is first degree price discrimination?  Example?
6. What is a reservation price? 
7. How might you graph first degree price discrimination?
8. Why is first degree price discrimination profitable?  Relate your answer to consumer surplus.
9. Why is first degree price discrimination difficult to pull off (at least perfectly)?
10. What is third degree price discrimination?  Example?
11. What must a firm be able to do to successfully practice third degree price discrimination?
12. How might you graph third degree price discrimination?
13. Why is third degree price discrimination profitable?  Relate your answer to consumer surplus.
14. What is second degree price discrimination?  Example.
15. What is a different between third degree and second degree price discrimination?
16. Firms that practice second degree price discrimination rely on consumer self-selection - explain.
17. How might you graph second degree price discrimination in the case of bulk discounts?
18. Why is second degree price discrimination profitable?  Relate your answer to consumer surplus.
19. What are different ways, besides amount purchased, that a firm might practice second degree price discrimination?  Examples.
20. Make sure you can show why block book pricing can be profitable.
21. What are some ways a firm can prevent resale?
22. Provide examples of each of the following classifications of price discrimination:  personal discrimination, group discrimination, product discrimination.
23. Relate the above classifications to 1st, 2nd and 3rd degree price discrimination.  Are there over-laps?

Topic:  Other Pricing Strategies

1. What is freemium pricing? Example?
2. Provide some explanations as to why a firm would use freemium pricing?  That is, how might this pricing strategy help the firm?
3. What are some possible downsides of using freemium pricing?
4. According to the Harvard Business Review article we discussed, how might a firm avoid the downsides of using freemium pricing?
5. What is a loss leader?  Example?
6. How can loss leaders be helpful to a firm?
7. What are some possible downsides of using a loss leader?
8. When pricing multiple or interrelated products - what is the basic economic theory that a firm "should" follow in order to increase profits?
9. Why might a firm have trouble following this theory?
10. There are two types of products with interdependent demands - complements and substitutes.  Define these and provide examples.
11. How would a firm go about determining (by using data - if they have it) if two or more of the products they sell are complements or substitutes?  Explain.
12. The basic objective a firm is not to make sure they are increasing profit from selling one good but instead to do what?
13. When a firm sells complements -- how would they determine the output level and price of each of the complements (theoretically) - assuming they can determine MR and MC?
14. When a firm sells substitutes - how would they determine the output level and price of each of the substitutes (theoretically) - assuming they can determine MR and MC?
15. If the firm did not include the MR of a complement, would they be producing too much or too little?  Explain.
16. If the firm did not subtract the MR of a substitute, would they be producing too much or too little?  Explain.

Topic:  Epipen Case

1. Be prepared to answer questions regarding the three readings on Epipen - the case, the editorial and the WSJ article.

EXAM THREE STOPS HERE

FINAL EXAM STARTS HERE

Topic:  Other Pricing Strategies (cont.)

1. What are common costs?  Example?
2. What is fully distributed cost pricing?  Example?
3. Why might fully distributed cost pricing lead to a bad business decision?
4. Instead of using fully distributed cost pricing, using marginal cost can lead to a better business decision.  Explain.  Example?
5. What does it mean for a firm to be vertically integrated?
6. What are a couple of problems that might arise in a firm (especially larger firm) that is vertically integrated?
7. What are diseconomies of scale and why do they take place?
8. What are profit centers and how can they decrease the problems with vertical integration?
9. What is transfer pricing?
10. When there is an external market - how is the transfer price determined?
11. What are some problems with using the market price as the transfer price?
12. If there is no external market, the standard theory would say that the firm should use the concept of choosing an output level where Marginal Revenue = Marginal Cost (total) and then determine the transfer price.  Explain this in words and graphically.
13. What are some other ways a firm might determine a transfer price?  What are some potential pitfalls?
14. What are some tax implications of transfer pricing when a firm has profit centers in different countries?  What should a firm do to minimize taxes?
15. Summarize the reasons that a firm might use transfer pricing.
16. What are some downsides to transfer pricing?

Topic:  Pricing - Ethics and Legal Issues

1. What are some ethical principles that might be used when determining a pricing strategy?
2. What are the implications of these principles?
3. Often times a pricing strategy might seem unethical in the short term - but the longer term outcomes might be very "ethical" or beneficial.  Price gouging could be an example of this.  What is price gouging?
4. Explain both in words and graphically how price gouging could be beneficial to the community.
5. How might price discrimination also be beneficial to the community?
6. What two government bodies are empowered to bring antitrust actions against firms?  Can private parties also bring civil action based on antitrust issues?
7. What was the first antitrust act (in 1890)?
8. Antitrust cases are often decided on the basis of the structure of the industry.  What does that mean?
9. On the other hand, competition can be defined as rivalry (behavior).  Explain.
10. What is the difference between a per se violation of the antitrust laws and a rule of reason decision?
11. What pricing practice is considered to be per se illegal?
12. What are horizontal territorial restrictions, bid rigging, a group boycott, and a tying agreement?  Examples?
13. Why do cartels (horizontal price fixing) tend to break down?  Explain. 
14. What conditions are conducive to a cartel being successful?
15. What is vertical price fixing or resale price maintenance (RPM)?
16. Is RPM per se illegal now?
17. Provide some arguments as to why (or conditions under which) RPM has been considered anti-competitive.
18. Why do firms want to use RPM?  What is inter-brand competition?
19. How might RPM might diminish free riding by low cost sellers?  Example?
20. See the article by Boudreaux for the next few questions:  What is predatory pricing - definition?
21. Provide an argument as to why predatory pricing should be illegal.
22. Why would predatory pricing probably never take place (at least as per many economists)?
23. What leads to quicker exit and entry in industries (according to the article by Boudreaux)?
24. Why are laws against predatory pricing sometimes seen as "dangerous" themselves? 
25. As per the question above, how might these laws actually decrease competition (rivalry)?