Managerial Economics

In Class Exercise Ten - Pricing Strategies Continued

 

1.  If a firm produces complements or substitutes -- it might over or under produce a good (with respect to profit maximization) unless it takes into consideration how revenue changes for the complement or substitute good as well.  Explain using just words.

 

Begin with how "profit maximization" is found: 

 

Then explain:

 

 

 

 

 

2.  Assume donuts and donut holes are complements in production or joint products produced by a company.

 

Assume the MC of producing the joint products is:  MC = 4 + 3Q

Price and MR equations are (remember, you can derive your P equations from your D equations):

Donuts - P = 25 - 2Q and MR = 25 – 4Q

Donut Holes - P = 20 – 1Q and MR = 20 - 2Q

a.  Determine the profit maximizing output level.

 

 

 

b.  What prices should be charged for the two joint products?

 

 

c.  How can you be sure that these prices ensure that you are operating both with a positive MR?

 

 

3.  What is fully-distributed cost pricing?

 

 

 

 

4.  Why might fully-distributed cost pricing not be profitable?  Instead -- what should a firm look at when decided to add a new product to it's line, for example?

 

 

 

 

5.  Assume the common costs for Barb's Barber Shop are $450 per month.  Barb has been distributing these costs across all of her barbers (she has 5 -- so they all have common costs of $90 each per month).  She is trying to decide if she should add another barber.  The marginal cost of adding the barber would be $50 per month.  Assume the maximum price a barber will pay to work in her shop is $65 month.

a.  If she uses fully-distributed cost pricing -- how much would she have to charge the barber to make it worth her while to add him? Is this feasible?

 

 

b.  If she used the marginal cost or incremental cost of adding the barber -- how much would she have to charge the barber and would this be a better pricing scheme?  If so - why?

 

 

 

6.  What is transfer pricing?  Relate transfer pricing to the concept of "profit centers."  When is the pricing decision "easy" with respect to a transfer price?  When it is not easy, what is the rule of thumb for the pricing decision.  Can you draw the graph that goes along with your explanation?

 

 

 

 

 

 

7.  What is cost - plus pricing?  Why might a manager NOT like cost - plus pricing?