Sunday, May 12, 2013
Price Discrimination | When pricing automobiles, American car companies typically charge a much higher percentage markup over cost for “luxury option” items (such as leather trim, etc.) than for the car itself or for more “basic” options such as power steering and automatic transmission. Explain why.
When pricing automobiles, American car companies typically charge a much higher percentage markup over cost for “luxury option” items (such as leather trim, etc.) than for the car itself or for more “basic” options such as power steering and automatic transmission. Explain why.
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This can be explained partially as an instance of third-degree price discrimination. Consider leather seats,
ReplyDeletefor example : Some people would like leather seats but are not willing to pay a lot for them, so their demand is highly elastic. Others have a strong preference for leather, and their demand is not very elastic. Rather than selling leather seats to both groups at different prices (as in the pure case of third - degree price discrimination), the car companies sell leather seats at a high markup over cost and cloth seats at a low markup over cost. Consumers with a low elasticity and strong preference for leather seats buy the leather seats while those with a high elasticity for leather seats buy the cloth seats instead.
This is like the case of supermarkets selling brand name items for higher prices and markups than similar store brand items. Thus the pricing of automobile
options can be explained if the “luxury” options are purchased by consumers with low elasticities of demand relative to consumers of more “basic” options.
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ReplyDeleteThis can be explained partially as an instance of third-degree price discrimination. Consider leather seats, for example. Some people would like leather seats but are not willing to pay a lot for them, so their demand is highly elastic. Others have a strong preference for leather, and their demand is not very elastic. Rather than selling leather seats to both groups at different prices (as in the pure case of third-degree price discrimination), the car companies sell leather seats at a high markup over cost and cloth seats at a low markup over cost. Consumers with a low elasticity and strong preference for leather seats buy the leather seats while those with a high elasticity for leather seats buy the cloth seats instead. This is like the case of supermarkets selling brand name items for higher prices and markups than similar store brand items. Thus the pricing of automobile options can be explained if the “luxury” options are purchased by consumers with low elasticities of demand relative to consumers of more “basic” options.