Econ 308 Final Review Part 1

Cost Center: is used when headquarter can measure:

• quantity & quality of output
• knows the cost function (what is cost function)
• Set the profit maximizing output & rewards
• 
  

• The Cost center has knowledge to choose the optimal mix (cost minimizing mix of input mix that can achieve that level of ouput) to minimize costs subject to and output target
• The incremental cost of producing the last unit of an output through the usage of any input should be the same across all inputs

Ex: Manufacturing units

Expense Center: is used when headquarter has difficulty to observe and measure output

• The Expense center has knowledge to choose the optimal input mix to minimize cost subject to a fixed level of service satisfaction (What is the difference between optimal input and optimal product mix??)

Ex: Personnel, Accounting & Research centers, Marketing centers
** Optimality condition for output-constrained cost minimization:

• Incremental cost due to the last unit of output through the usage of any input should be the same across all inputs.

Revenue Center: is used when headquarter has knowledge of demand to set the profit maximizing price for an optimal input mix, while the revenue center has knowledge to choose the optimal input mix (such as advertising & product promotion) to maximize revenue for given price targets and cost budget.
Ex: Retail & Wholesale units ** Optimality condition for cost-constrained revenue maximization given product price: (??)

• Incremental revenue due to the last dollar spent on each promotion activity should be the same across all promotions activities.

• Profit Center: is used when the profit center has the knowledge to choose the optimal input mix & the price or quantity of an optimal of an optimal product mix to maximize profit.
  • Consists of Revenue, Cost & Expense centers.
  Ex: Cadillac division of GM. Cadillac is one profit center of GM (how to choose how many products to produce)
  
  • Profit maximization Marginal Revenue = Marginal Cost
  • Competitive Firm Price = Marginal Revenue
  • Market (Monopoly) Power because there is downward slope you end up with ……… Price > Marginal Revenue
  Five Sources of Market Power:
  • Essential Inputs (strategic assets) Ex: a diamond jeweler relies on a company that controls all diamonds
  • Economies of scale and scope
  • Economies of scope the cost of producing two or more products together are cheaper than the sum of producing each one separately
  • Economies of Scale When you produce larger volume, the average cost of production will be less.
  • Product Differentiation: Quality, Warranty, Brand Name
  • Government regulation
  • Entry barrier

Third Degree Price Discrimination: is the situation where a firm can sell to different consumers (different markets) at different prices.

• • Profit maximization: requires marginal revenue in each market = marginal cost
  • Leads to the inverse demand elasticity rule
  Ex:
  • Movie ticket Prices
  • Dry cleaners
  • Best Price Policy If you find a find a better price they will guarantee you that price ex: Best Buy
  • Coupons
  • Senior Citizen, Student, and group discount
  
  

• Inverse Demand Elasticity Rule: requires a firm to sell a product to consumers with higher own-price demand elasticity at a lower price and to consumers with lower own-price demand elasticity at a higher price.
• If two there are two group of customers

1^st Group – if there is more elastic demand charge them a lower price 2^nd Group – If there is less elastic demand charge them a higher price

• • First Degree Price Discrimination Monopolist Every unit at a different price Ex: Auction house
• Two-Part Tariff Monopolist Membership fee + price per unit (EX: Costco)
• All-or-Nothing Contract Monopolist Fixed quantity + price per unit (Ex: Costo Sell big quantities

Second Degree Price Discrimination: is selling different blocks of units to the same consumer at different prices. (Two Types)

• Volume Discount or Declining Block Pricing: the more you buy the cheaper it is for the next blocks of units.

*Typical for wholesale selling to retailers

• Increasing Block Pricing: when you buy more units, the next blocks of unit will cost more.

*Mainly for Utility *Ex: If you have a cell phone plan with 700 minutes, if you exceed this amount you have to pay .49 cents more per minute.

Product Bundling: requires buyers to buy two or more products at a set price or no deal.

Fourth Degree Price Discrimination: is selling to different consumers at the same price but the cost of providing the products to different consumers are different.

• Profit margin is difference
• Ex: Buying an airplane ticket and then calling them telling them you are Jewish so you need kosher food mostly costly to the company

Peak Load Pricing: occurs when firms discriminate consumers by selling to them at different prices at different times for the same quality product.

Dominant Firm Price Leadership Model: can explain coexistence of a low-cost large firm with many high-cost fringe firms.

Transfer Pricing: is the pricing of an intermediate good sold from one division of a firm to another division of the firm.

• Managerial Point of View transfer price should be set to the competitive market price of the intermediate good if a competitive market for the product exists, or to the marginal cost of producing the intermediate good by the firm so as to clear the internal market for the intermediate good if a competitive market for the product does not exist. (??)