F&D P2: Decision-Making and Strategies

What is the general decision-making principle for firms?

To maximize profits (PC firms adjust output, imperfect competition firms set price AND output).

What are motivations for a firm's strategy? (Reasons for Firm Strategy)

Increasing revenue, lowering costs, responding to competitors, business risks/uncertainty.

What is Uniform Pricing?

A firm sells all units of its output at the same price, and charges all its customers the same price for the same good.

What is Price Discrimination?

A producer sells the same good at different prices where the price difference does not reflect differences in the cost of supplying the customer.

What is the Primary Objective of Price Discrimination?

To increase firm profits by capturing consumer surplus and increasing sales volume, potentially lowering unit costs through EOS.

What are the Necessary Conditions for Price Discrimination? (Conditions for PD)

Seller must have market power, firm must be able to identify/segment market by PED, firm must be able to prevent resale/arbitrage.

How does a firm segment market by PED? (Method for PD)

By customer characteristics (age, student status, residency), location, or past purchase behavior (e.g., loyal customers less price elastic).

What is Arbitrage?

Buying a good at a lower price and reselling it at a higher price. Prevention is crucial for price discrimination effectiveness.

What are the Benefits of Third-Degree Price Discrimination?

Increased profits (capturing CS, increasing sales volume, exploiting EOS), cross-subsidisation of loss-making activities/services.

What are the Limitations of Price Discrimination?

Effectiveness limited by ability to segment market and prevent resale. High costs of prevention -> lower profitability.

What is Predatory Pricing?

Deliberate strategy to drive competitors out of market by setting very low prices (or below AVC in SR).

What is the Credibility of Predatory Pricing?

Predator needs sufficient past supernormal profits or cross-subsidisation to cover losses and demonstrate commitment.

What are the Limitations of Predatory Pricing?

Can trigger price wars, unsustainable in LR, may hurt brand image, ineffective if entrants can absorb losses.

What is Limit Pricing?

Pricing strategy used by incumbent firm(s) to deter entry by setting a price below the profit-maximising price but above the competitive level.

How effective is Limit Pricing?

More effective in industries with high sunk costs; incumbent firms have first-mover advantage and lower AC.

What are Discounts?

Reducing prices to increase sales volume (movement along AR curve).

What are the Limitations of Discounts?

May lead to perception of lower quality -> demand fall. May trigger price wars.

What are Non-Price Strategies?

Strategies used by a firm to differentiate its product/service from rivals to increase demand and reduce PED without changing price.

What is Product Differentiation?

Variations within a product class that consumers view as substitutes. Can be real physical differences, imaginary differences, or differences in conditions of sale.

What is Salience Bias? (Cognitive Bias tapped by PD)

Tendency to focus on prominent information over less prominent but relevant information. Firms use this (simple design, personalization) to influence choices.

What is Advertising?

Marketing strategy to differentiate products, increase demand, and reduce PED by highlighting uniqueness and creating perceived differences.

What is the purpose of Advertising?

To inform, persuade, and convince consumers to purchase, build brand loyalty, and increase switching costs for rivals' products.

What are the Limitations of Advertising?

Costs may outweigh benefits (fixed costs), revenue increase may only be long-run, campaigns may backfire, susceptibility to sunk cost fallacy.

What is "Free Gift With Purchase While Stocks Last" Promotion?

Non-price promotion using scarcity/urgency signals, targeting loss aversion bias.

What is Loss Aversion Bias?

Cognitive bias describing tendency to prefer avoiding losses to acquiring equivalent gains. Firms tap this to foster customer retention.

What are Customer Loyalty Rewards Programs?

Programs (e.g., loyalty schemes, points) that increase switching costs for consumers, fostering retention and demand.

What is Research and Development (R&D) Leading to Product Innovation?

Activities undertaken to innovate and introduce new/improved products and services.

What is Process Innovation?

Changes in equipment/technology, supply chain, tools, methods to reduce average/marginal costs (e.g., automation).

What are the Limitations of Product Innovation?

Effectiveness may be temporary (rivals can copy features), costly, and susceptible to sunk cost fallacy.