NOTES 1 increased at the same proportion, output
may increase by a larger proportion than
Economies of Scale and Scope the increase in input due to some
factors that may lead to lower average
Law of diminishing marginal returns (Law costs.
of variable proportions)
It says that as successive increments of Economies of scope
a variable resource are added to a fixed a. Economies of scope between two
cost, the marginal product of the products occur if the cost of producing
variable resource will eventually decline. two products jointly is less than the cost
of producing those two products
Diminishing marginal returns is a short-run separately:
horizon Cost (Q1, Q2) < Cost(Q1) + Cost (Q2)
phenomena caused by fixed of at least b. Diseconomies of scope between two
one factor of production such as land, products occur if the cost of producing
plant, building, machineries two products jointly is higher than the
cost of producing them separately:
Diminishing marginal returns is a long-run Cost (Q1, Q2) > Cost (Q1) + Cost (Q2)
horizon
factors of production can be changed Complex pricing
including buildings, size and number of 1. Pricing commonly owned products
plants and others which means that the a. After acquiring a substitute good,
fixed cost becomes a variable cost raise price on both goods but raise
price more on the more elastic (low
Diminishing marginal productivity
margin) product. After acquisition, it
the marginal cost is increasing, and the is advantageous to cut output or
increasing marginal cost leads to increase price.
increasing average costs that will result b. After acquiring a complementary
to decreasing profit good, reduce price on both products
to increase profit.
Economies of scale
a. Constant returns to scale mean that
2. Advertising pricing
the long-run average costs are constant
a. If promotional expenditures make
or does not change in relation to the
demand more price elastic, then
output. A certain increase in inputs will
reduce price when promoting the
have same increase in output.
product
b. Diseconomies of scale means that the
b. If promotional expenditures make
long-run average costs rise. it is an
demand less price elastic, then
increase in all inputs, let us say 15%,
increase price when promoting the
that will result to a less than
product.
proportionate increase in output, let us
consider less than 15%. It may occur at
3. Revenue Management and pricing
a very large output.
a. If MR > MC at capacity, then set
c. Economies of scale means that long
price to fill available capacity
run average cost falls, if all inputs are
With MR > MC managers consider reducing more intensely than gains. A price increase will
price to sell more but cannot do so because be felt more intensely (consumer loses) than
the firm’s capacity is limited, so firms sell as price reduction (consumer gains).
much as it can or set price to fill capacity.
On the other hand, if demand cannot be
predicted, pricing to fill capacity becomes
difficult.
optimal price – balance the cost of over-
pricing (lost profit on unfilled rooms)
against underpricing cost (lower margins
on all the rooms)
If the loss of profit from these pricing is
symmetric, the firm should price (target
price) so as the expected demand is just
equal to capacity.
if the overpricing lost profit is less than
the lost profit from underpricing cost,
then the firm should overprice
if the overpricing lost profit is more than
the lost profit from underpricing cost,
then the firm should lower price or lower
than the target price
a. If the cost of overpricing (unused
capacity) is smaller than the cost of
underpricing (lower margins), then
price higher than would fill capacity,
or price otherwise (vice versa)
4. Psychological pricing
a. Managing price expectations is as
important as managing price
As implied in the prospect theory, consumers
are motivated by a comparison of the price
level to the reference price (how much we
expect something to cost) not by the actual
price level.
b. Integrate losses but separate gains
Also implied in the prospect theory, consumers
are loss averse which means losses are felt
