9 Pricing Arrangement and Consumer Surplus
9.1 Types
(1) Packages
[1] Method
- Sellers sell their commodities in packages of different sizes for sale
- The larger package is charged with a lower average price than that of the smaller package
- Example:
- The price for a bottle of shampoo which has1000ml is $30, then the average price per ml is $0.03
- The price for a bottle of shampoo which has 500ml is $20, then the average price per ml is $0.04.
- That is a discount is offered to buying for some more units
- This complies with the law of diminishing marginal use value which states that the marginal use value is diminishing as more unit is consumed. Therefore, a lower price must charge for the additional units.
- The larger package is charged with a lower average price also complies with the law of demand which states that as the price of the commodities decreases, its quantity demanded increases.
- Actually, selling in packages is applying the principle of All-or-nothing pricing to obtain the consumer surplus.
[2] How to set the price per package
|
Q
|
MUV=MR
|
TUV=TR
|
AUV
|
AVERAGR PRICE
|
MC
|
|
1
|
18
|
18
|
18
|
18
|
8
|
|
2
|
16
|
34
|
17
|
17
|
8
|
|
3
|
14
|
48
|
16
|
16
|
8
|
|
4
|
12
|
60
|
15
|
15
|
8
|
|
5
|
10
|
70
|
14
|
14
|
8
|
|
6
|
8
|
78
|
13
|
13
|
8
|
|
7
|
6
|
84
|
12
|
12
|
8
|
|
8
|
4
|
88
|
11
|
11
|
8
|
- A producer will produce when MR＞MC since he has profit and stops producing at MR=MC as there is no more profit.
- The producer will produce up to 6 units since MR=MC.
- And the producer will sell his commodities in a package of 6 units for $78, since it has highest TR.
- Since consumers’ preferences are different and information is scarce in real world, packages of different quantities are sold to capture the consumer surplus of various consumers.
- Selling in package is more likely to apply in selling of commodities that are difficult to split and resell to avoid reselling among consumers. Since producers may lose their revenues if reselling occurs.
(2) All-or-nothing pricing arrangement
- Since TUV = TEV, so all consumer surplus is extracted by the seller
(3) Price discrimination
[1] Methods
{1} A seller sells the same commodity to different consumers at different prices. e.g. MTR charges children and adults different prices
{2} Charges the same consumer different prices for different units of a commodity
{3} Providing discount i.e. units of good has higher MUV will be sold at a higher price
- With quantity discount, most consumer surplus is extracted
- Example:
|
Q
|
TUV($)
|
MUV($)
|
TEV($) - @$8
|
|
1
|
10
|
10
|
8
|
|
2
|
19
|
9
|
16
|
|
3
|
27
|
8
|
24
|
|
4
|
34
|
7
|
32
|
|
5
|
40
|
6
|
40
|
|
6
|
45
|
5
|
48
|
|
7
|
49
|
4
|
56
|
|
8
|
52
|
3
|
64
|
|
9
|
54
|
2
|
72
|
|
10
|
55
|
1
|
80
|
- Under single pricing arrangement (single price is charged per unit)
If P = $8, Q = 3, TEV = $24, TUV = $27
Then Consumer surplus = TUV – TEV = $3
If single price = @$10
If you buy 3 units, you get 15% discount
Then TEV = $10 x 3 x 0.85 = $25.5
TUV = $27
Consumer surplus = TUV – TEV = $1.5
- That is by using discount, the seller can obtain more of the consumer surplus
(4) Two part pricing/Two part tariff/Membership free
[1] Method
- A consumer needs to pay a lump sum fee for the right to buy a good or services and then the consumer needs to pay an additional fee for each unit of the commodity or service they want to consume.
- For example, the rental of video tapes
[2] How to set the price
- Sellers will ask consumers to pay a lump-sum equal to the amount of consumer surplus.
Given : A consumer’s quantity demanded for video tape is
Qd = 100 –50(P)
When : P = $1
Then : Qd = 100 – 50($1) = 50
That is the quantity demanded for video tape is 50 when the price is $1
When : Quantity demanded = 0
That is the consumer pays only the membership fee
Then : Qd = 100 – 50(P)
0 = 100 – 50(P0)
P0 = $2
So : Consumer surplus = 1/2 (base x height)
= 1/2[($2 - $1) x 50] = $25
- That is the membership charged will be $25.
- Transaction costs are involved in checking the membership in order to prevent resale.
(5) Tie-in sale
- It is an offer to sell a commodity at a given price on condition that the buyer also buys another commodity at a stated price.
- For example, Polariod instant photo camera and Polariod photo film
- It uses the tied item (Polariod photo film) as a means to collect more TUV of the tying item (instant photo camera)
10 The law of demand is always held true
- Argument
- Increasing prices are associated with increasing sales or purchases
- That is an increase in price leads to an increase in quantity demanded
- Explanation
(1) People have confused the relative price with nominal price
- If the nominal price of a commodity (Commodity X) has increased during inflation and if the nominal prices of other commodities (Commodity Y) have increased even more, the quantity demanded of the commodity (Commodity X) increases
- When the value of Py is greater than Px, the value of Px/Py becomes smaller
- It is because Px/Py has decreased, that is the relative price of the commodity is decreased.
- According to the law of demand, when the relatively price of a commodity decreases, its quantity demanded increase.
- So an increase in price (nominal price) leads to an increase in quantity demand.
- That is to say the law of demand is held true
(2) People have confused the listed price and transacted price
- The nominal price may not be the price of an actual transaction
- There are all sorts of discounts and concessions occur during a transaction
- If there are discounts or concessions, the nominal price of the commodity decreases.
- That is the value of Px decreases holding the value of Py constant, therefore, the value of Px/Py becomes smaller
- Therefore, the relatively price of the commodity decreases
- According to the law of demand, when the relatively price of a commodity decreases, its quantity demanded increase.
- So an increase in price (nominal price) leads to an increase in quantity demanded
- That is to say the law of demand is held true
(3) People have confused between a change in quantity demand and a change in demand
- When the quantity demanded of a commodity increases while its prices increases, it may be the result of a change in demand rather than a change in quantity demand
