Decision Making in Economics



Table of Contents

Introduction3

Discussion4

Conclusion7

Decision Making in Economics

Introduction

Price discrimination is a widely used marketing tactic. It is present when two or more identical units of the same products or services are sold at different prices, either to the same buyer or to different buyers. It is more often observed in sales to end-use buyers (consumers) than in intermediate-goods markets (where the buyer is a manufacturer, wholesaler, or retailer); this is because in many countries price discrimination in intermediate-goods markets is considered to be an “unfair” practice by antitrust authorities.

Price discrimination is also known as “flexible pricing” or “targeted pricing.” Since they sound neutral, these alternative names are often used by the business community (Armstrong, M. and Vickers, 2003).

But in some industries firms produce more than one good and have costs (some of them sunk) that are common. Firms then face a problem of raising revenue from buyers to cover common costs in order to survive in the long run. It is widely accepted that the classical view of competition does not have a good explanation for the recovery of common costs in a competitive environment, where firms usually sell at a price equal to marginal cost. The definition of cost is somewhat troublesome. Traditional textbooks teach us that in the short run firms have both fixed (possibly sunk) cost, which does not vary with output, and variable cost, which is an increasing function of output. In the long run all costs are variable, which means there should be no sunk cost (Stavins, J., 2001).

Discussion

Recently, there have been some critics of this widely accepted distinction. As Elhauge et al (2003, p681) suggest, there could be a kind of sunk cost even in the long run. They call this “recurring” or “repeating” sunk outlays, which could be the license fee that should be paid to operate in the market or R&D expenses needed to be able to survive in the future. Substantial sunk cost is a well-known entry barrier, but these recurring sunk outlays may not deter entry because they are equal burdens for the entrants and the incumbents.

As Baumol pointed out “it is these expectable and recurring sunk outlays that most directly drive the firm to discriminatory pricing” (Armstrong, M. and Vickers, J, 2001).

Even very small airlines were able to enter and compete in dense routes if able to secure a gate and landing slot at the airports. It is worth noting that deregulation did nothing about the competition in airports (Stewart, James and Rankin, Keith, 2008). Today, airports are still the missing leg of deregulation. Difficulty gaining access to airports decreases the chances for smaller entrants. Some successful low-cost carriers solved this problem by offering services at nearby, less-utilized, airports. Initially, low cost carriers were only serving a small fraction of the market (9.2 % in 1984). However, as they started to serve more and more city pairs, they continued to attract more passengers. Increasing service quality and broader networks, eventually decreased the loyalty ...