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GROUP 2 - TWO-PART PRICING & BLOCK PRICING MEMBER LIST

No.

Full name

Student ID

1

Trịnh Ngọc Ánh Dương

1201016104

2

Nguyễn Ngọc Hồng Duyên

1201016111

3

Phạm Thị Thanh Hà

1201016128

4

Nguyễn Thị Minh Hằng

1201016143

5

Nguyễn Công Huy

1201016195

6

Nguyễn Minh Huy

1201016197

7

Nguyễn Cát Xuân Khanh

1201016211

8

Trần Huỳnh Ái Lâm

1201016230

9

Nguyễn Trường Liêm

1201016239

Bùi Đăng Minh

1201016287

10

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1. Two-part pricing strategy 1.1. Brief explanation 1.1.1. Definition Two-part pricing is a pricing strategy where consumers are charged a fixed fee for the right to purchase a product, plus an additional per-unit charge for each unit of product purchased. In other words, this kind of price consists of two components: first, a lumpsum fee; and second, a per-unit charge. 1.1.2. Illustration of two-part pricing strategy Suppose consumer demand function of Costco Club is Q = 10 – P and the cost function is C(Q) = 3Q as demonstrated in figure 1.1 below. If this club charge a simply single price for all customers, the profit – maximizing level of output would be Q = 3 and the profit – maximizing price would be P = 7. This corresponds to the point where marginal revenue equals marginal cost. With this price-quantity combination, Costco Club gets the profit of $12, which is represented by the shaded rectangle ABCD. Moreover, the consumer surplus of all consumers in the market is the triangle ABE, which values $4.5. This means that the consumers receive the value of $4.5 from 3 units that they did not pay for. Figure 1.1. Standard monopoly pricing P 10 E Consumer surplus = $4.5 B

A Monopoly =7 price

Profits = $12 C

D

MC = AC

3

0

3

MR

10

Q

Source: Based on microeconomic theory Now suppose Costco Club’s demand and cost curves do not change, but the club change its pricing strategy that it charges all of its consumers an annual hip fee of $24.5 allowing the customers to access into the club. Additionally, it charges $2 for each time they use the gym facilities.

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Figure 1.2. Two – part pricing demonstration

P 10

E

Consumer surplus = 0 Fixed fee = $24.5 = profits

D

C MC = AC

3

0

7

10

Q

Source: Based on two-part pricing principle This situation is graphed in figure 1.2. In this case, the consumers will purchase 7 units and receive a consumer surplus of $24.5. Moreover, the club has a per-unit charge of $3, which is equals to the marginal cost of the club showing that Costco Club makes no profit on each unit sold. However, the club still makes profit from charging a fixed hip fee of $24.5 from all consumers. In other words, with two-part pricing strategy, Costco Club would be able to extract the entire consumer surplus from it consumers. From the demonstration of Costco Club, it is clearly summarized that the two-part pricing can be conducted through three steps: - Set price at marginal cost; - Compute consumer surplus; - Charge a fixed fee equals to consumer surplus.

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With this pricing strategy, the firm can extract additional surplus from the consumers and enhance its profits simultaneously. 1.2. Further problems 1.2.1. Two-part pricing when consumer demand is homogeneous

-

When consumers have homogeneous demand, any one consumer is representative of the

-

market (the market being n identical consumers) If the firm is perfectly competitive, it would charge price P c and supply Qc to our

consumer  no economic profit but producing an allocatively efficient output - If the firm is a non-price discriminating monopolist, it would charge price Pm per unit and supply Qm  maximizing profit but producing below the allocatively efficient level of output Qc.  Economic profit for the firm: the green area B, consumer surplus: to the light blue area A, -

a deadweight loss: the purple area C. If the firm is a price discriminating monopolist, the firm must charge the perfectly competitive price per unit, Pc, because this is the only price at which Qc units can be sold. To make up for the lower cost per unit, the firm then imposes a fee upon our consumer equal to her consumer surplus, ABC. If there are multiple consumers with homogeneous demand, then profit will equal n

times the area ABC, where n is the number of consumers. 1.2.2. Two-part pricing when consumer demand is different - There are two consumers, X and Y. Consumer Y's demand is exactly twice consumer X's demand.

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-

The firm would like to follow the same logic as before and charge a per-unit price of P c while imposing a lump-sum fee equal to area ABCD - the largest consumer surplus of the

two consumers  The firm will be pricing consumer X out of the market - A solution to pricing consumer X out of the market is equal to charge P c per unit. Profit in this instance equals twice the area AC (two consumers): 2 x AC=ABCD  The profit is the same and the producer is indifferent to either of these pricing -

possibilities It can be seen that applying two-part pricing in doing business may arise the risk of increasing istrative and management costs, because the firm, if it wants to enhance the profits efficiently, needs to narrow the target market, in order to set the appropriate

per-unit charge for each group of consumers. 1.3. Application 1.3.1. Market power or market structure Firm having two following conditions should utilize two-part pricing strategy: - The firm has market power, including three specifice types of power: monopolitic -

competition, oligopoly and monopoly. The firm’s customers may have either identical or different demand curves. This strategy tends to work best when consumer demand is relatively homogeneous. In practice, it is the matter of market power and type of commodities that the firm

needs to consider when applying two-part pricing strategy. Particularly, there are several examples of two–part pricing strategy used in amusement parks, museums, bookstores, telephone services and access to website information. It can be said that two-part pricing is also used in those markets, where producers charge a lump sum to a retailer for the right to carry their products plus a constant charge per unit ordered by the retailer.

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Recently, two-part pricing can also be seen in several technology licensing agreements, which specifies a fixed fee and a royalty for each unit produced. 1.3.2. Real life examples Disneyland’s ission fee This is a classic example of two-part pricing strategy, which was analyzed in the article written by Walter Oi in 1971. Disneyland is said to maximize it profits by setting prices for ission to the theme park and for individual rides. Applying the two-part pricing strategy, when considering all visitors are identical, the optimal strategy is to sell rides at the price equated to marginal cost. In case that the consumers’ tastes are different and the park’s management board can realize the relation in the population between rides demanded and consumer surplus, it is able to set two different prices, where Disneyland can still enhance its profits. This means that the perunit price of each individual ride is the same for all visitors. However, each visitor would be charged a different fixed ission fee that converts his entire consumer surplus into Disneyland’s profits. Polaroid camera and Polaroid film Polaroid Corporation introduced its SX-70 instant camera, which uses the film made exclusively by Polaroid. With this product, Polaroid used two-part pricing strategy for pricing of camera and film. This allowed them to create greater profits than it would have been possible if camera used ordinary film, which can be produced by any other firms. It can be seen that buying the camera is like the entrance ticket of Disneyland, which allows the consumers to buy and use the film and camera. However, unlike the theme park, the marginal cost of providing an additional camera is considerably higher than zero. The articles concerning this pricing strategy argued that it was necessary for Polaroid to have monopoly for two reasons: first, if Polaroid camera could work with ordinary film, the price of film would be close to marginal cost; second, when launching Polaroid camera, Polaroid Corporation needed to make most of its profits from the sale of film. In the end, the film’s price was significantly above marginal cost and there was considerable heterogeneity of consumer demands. 2. Block pricing 2.1. Brief explanation 2.1.1. Definition

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Block pricing is the practice of charging different prices for different amount or block of a good service, such as selling a package of eight paper rolls or a six-pack of beer. The idea behind block pricing is to charge a package price that includes some consumer surplus. 2.1.2.

Illustration of block pricing strategy To illustrate the ideas behind block pricing, suppose that the manager of a

supermarket purchase paper rolls from a distributor for 0,1 $ each. The inverse demand equation of a typical customer is P = 0.3 – 0.025Q Suppose the manager adopts a one-price strategy. To maximize profit, the manager should charge a price such that MR=MC. The supermarket's marginal revenue equation is MR = 0.3 – 0.05Q Since MC=0.1, the supermarket should charge P=0.2 per roll and sell Q=4 rolls per buyer. The supermarket's per customer operation profit is TR – TVC = 0.4 Now, suppose the manager adopts a block pricing strategy by selling multiple paper rolls in a package. How many rolls should be included in the package, and at what price? What is the supermarket's per customer operating profit? The answers to this question are illustrated in Figure 2.1 below. To determine the number of paper rolls in each package, equate price in P= 0.3 – 0.025Q to marginal cost. Solving, the optimal number of paper rolls per package is Q=8. The price charge per package equals to the total value received by the buyer, which is given by the shaded area in the figure. which is equal to the sum of consumer surplus and total variable cost. In this example, the price per package is TR=0.5(0.3 - 0.1) 8 + 0.1 x 8 = 1.6 The supermarket’s operating profit equals consumer surplus of TR – TVC= 1.6 0.8 = 0.8 which is 0.4 greater than the operating profit when selling paper rolls one at a time. Figure 2.1. Block pricing

8 P

0.2 MC

0.1 0

MR 4

8

10

Q

2.2. Further problems Block pricing poses an “all-or-nothing” situation for consumers. However, if the price for the package is higher than the acceptable value for consumers, they can stop buying all together. Furthermore, block pricing can be effective where price discrimination would fail. Figure 2.2. Relationship between block pricing and value consumers receive

2.3. Application Market with somewhat standardized and necessary products such as toilet papers, instant noodles. Some real-life examples which can be easily recognized are supermarkets, grocery stores… 3. Comparison between two strategies Benefit

Two-part pricing Blocking pricing Allow firms to gain larger profits than they normally would at the monopoly price The firms extract more of the consumer surplus by The firms extract the maximum charging a fixed fee equal to the total consumer

consumer surplus by forcing

surplus and set per-unit fee equal to marginal cost

consumers to make an all-or-

9 to ensure that the surplus is as large as possible.

none decisions to get the full total value of the products they

Environment

There are several examples of two-part tariffs in

receive. Block pricing is frequently

retail

parks,

used by supermarkets to extract

various types of sports, museums, bookstores,

the most value out of the

discount shopping or other clubs, telephone

consumers. An example is a

services, and access to website information.

package

Two-part pricing are also often used in wholesale

Oftentimes the supermarkets

markets, where manufactures charge a lump sum

will bundle the toilet paper into

to a retailer for the right to carry their product plus

units of 24 or 48 to force the

a constant charge per unit ordered by the retailer.

consumer to buy the large pack

One reason to set a two-part price is to cover some

or not to buy the pack at all. By

customer-specific fixed cost, such as the cost of

packaging the toilet paper in

connection in telecommunications or the cost of

this way, the supermarket can

line rental.

earn a larger profit.

markets,

including

amusement

For instance, in February 2011, Singapore Telecom’s rate for a residential fixed line was S$29.43 for three months plus a usage charge of 0.86 to 1.72 cents per 60 seconds, depending on the time of day.

of

toilet

paper.