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Week 11: Profitability and Pricing 2 - Pricing Strategy - Coggle Diagram
Week 11: Profitability and Pricing 2 -
Pricing Strategy
Reservation price and Consumer surplus
Reservation price
maximum price that a customer will buy the product
represents the
maximum willingness to pay
of a customer
Consumer surplus = Reservation price - price paid by customers
example: page 5
Maximum Reservation Price
(MRP): least price at which demand is 0
Maximum Willingness to Buy
(MWB): expected demand when the product is free
Price elasticity
Price elasticity = % change in quantity/ % change in price
Price elasticity is negative for all products except
Giffen
and
Veblen
(status- seeking) goods
3 categories
| PE | = 1 => unitary elastic
| PE | > 1 => price elastic
| PE | < 1 => price inelastic
example:
page 9
% change at
current price
Linear Demand
Q = MWB x ( 1 - P/ MRP)
=> diagram on page 11
linear equation
a = MWB (
intercept
)
b = - (MWB/ MRP) (
slope
) => downward sloping
page 12
for more details
MWB = Q1 - [(Q2 - Q1)/ (P2 - P1)]
P1
(example: p.13)
MRP = P1 - [(P2 - P1)/ (Q2 - Q1)]
Q1
(example: p.13)
price elasticity
elasticity = slope x (P1/Q1) = -(MWB/ MRP)(P1/Q1)
more detail on
page 14
example: p.15
optimal price
the relationship between
total contribution
and
price
is an
inverse U- shape
optimal price = (MRP + variable cost)/ 2
Gross Margin (%) at optimal = -1/ elasticity at P*
Contribution
= (MWB/ MRP)
(P* - VC)^2 ???
page 18
MWB = -slope x MRP
(where slope is elasticity of demand)
Constant elasticity demand
elasticity is constant
while the slope changes at every point
elasticity = ln(Q2/ Q1)/ ln(P2/ P1)
Model
: Q = A*P^(ELAS)
A: scaling factor
graph:
p.19
Q2 = (P2/P1)^(ELAS) x Q1
(example: p.20)
optimal pricing
optimal P = variable cost x (ELAS/ 1 + ELAS)
Residual price elasticity
Residual elasticity
= E1 + E2*E3
E1 = Own price elasticity
E2 = Competitor Reaction Elasticity =
% change in competitor's price = % change in own price
E3 =
Cross elasticity
=
% change in quantity sold/ %change in competitor's price
Change in sales (%) = Own price change (%) x Residual price elasticity
(example: p.24)
Using
regression
: p.25