Some years ago, an article appeared in the New York Times about IBM’s pricing policy. The previous day,IBM had announced major price cuts on most of itssmall and medium-sized computers. The article said:

IBM probably has no choice but to cut prices periodicallyto get its customers to purchase moreand lease less. If they succeed, this could makelife more difficult for IBM’s major competitors.Outright purchases of computers are needed for ever larger IBM revenues and profits, says Morgan Stanley’s Ulric Weil in his new book, InformationSystems in the 80’s. Mr. Weil declares that IBM cannot revert to an emphasis on leasing.

a. Provide a brief but clear argument in support of the claim that IBM should try “to get its customers to purchase more and lease less.”

b. Provide a brief but clear argument against this claim.

c. What factors determine whether leasing or selling is preferable for a company like IBM? Explain briefly.

Short Answer

Expert verified
  1. It will increase the revenue of IBM.

  2. IBM will lose those consumers who could pay the lease price but not the total price of the computer.

  3. The knowledge of demand and consumers reservation prices for computers determine whether leasing or selling is preferable.

Step by step solution

01

Step 1. Argument in support of the claim

The claim states that IBM should cut prices of its computers periodically so that more consumers can afford to buy them. If IBM does this, its revenue will increase with each computer sold in the market. It can improve the demand for its computers by systematically abolishing the lease of computers to its potential consumers.

The decreased availability of computers for lease will compel consumers to purchase computers and continue their work. The decrease in the price of small and medium-sized computers will allow more consumers to buy them. Both the decisions will increase the number of computers sold by IBM in the market. The market share will increase along with the revenue.

02

Step 2. Argument against the claim

The article suggests decreased leasing of computers. If IBM decides to cancel this system, it will lose those consumers who can afford the lease price but not the buying price of computers. IBM may end up decreasing its demand in the market.

03

Step 3. Factors that will determine the preferable pricing decision

  • Knowledge of demand:Before deciding to go for a lease pricing strategy or selling strategy, IBM should try to gain all the possible knowledge regarding the demand for computers in the market. It will help the company to know about its potential consumers.

The company will be able to price discriminate between consumers with the help of 'knowledge about demand' and earn a maximum profit under different pricing policies.

  • Reservation price of consumers for computers:The company should conduct surveys and adopt several other methods to measure the reservation price of its consumers. It will help the company categorize the consumers based on their reservation prices.

It can then decide about both strategies' overall benefit (lease or sell).

The above factors will help IBM judge the preferable system of providing computers to its consumers.

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Most popular questions from this chapter

Your firm produces two products, the demands for which are independent. Both products are produced at zero marginal cost. You face four consumers (or groups of consumers) with the following reservation prices:

CONSUMER GOOD 1(\() GOOD 2(\))

A 25 100

B 40 80

C 80 40

D 100 25

a. Consider three alternative pricing strategies: (i) selling the goods separately; (ii) pure bundling; (iii) mixed bundling. For each strategy, determine the optimal prices to be charged and the resulting profits. Which strategy would be best?

b. Now suppose that the production of each good entails a marginal cost of $30. How does this information change your answers to (a)? Why is the optimal strategy now different?

Consider a firm with monopoly power that faces the demand curve

P= 100 - 3Q+ 4A1/2

and has the total cost function

C= 4Q2 + 10Q+ A

where Ais the level of advertising expenditures, and Pand Qare price and output.

a.Find the values of A, Q, and Pthat maximize the firm’s profit.

b.Calculate the Lerner index, L = (P - MC)/P, for this firm at its profit-maximizing levels of A, Q, and P.

Suppose that BMW can produce any quantity of cars at a constant marginal cost equal to \(20,000 and a fixed cost of \)10 billion. You are asked to advise the CEO as to what prices and quantities BMW should set for sales in Europe and in the United States. The demand for BMWs in each market is given by

QE = 4,000,000 - 100PE

and

QU = 1,000,000 - 20PU

where the subscript E denotes Europe, the subscript U denotes the United States. Assume that BMW can restrict U.S. sales to authorized BMW dealers only.

  1. What quantity of BMWs should the firm sell in each market, and what should the price be in each market? What should the total profit be?
  2. If BMW were forced to charge the same price in each market, what would be the quantity sold in each market, the equilibrium price, and the company’s profit?

Elizabeth Airlines (EA) flies only one route: Chicago–Honolulu. The demand for each flight is Q = 500 - P. EA’s cost of running each flight is \(30,000 plus \)100 per passenger.

  1. What is the profit-maximizing price that EA will charge? How many people will be on each flight? What is EA’s profit for each flight?
  2. EA learns that the fixed costs per flight are in fact \(41,000 instead of \)30,000. Will the airline stay in business for long? Illustrate your answer using a graph of the demand curve that EA faces, EA’s average cost curve when fixed costs are \(30,000, and EA’s average cost curve when fixed costs are \)41,000.
  3. Wait! EA finds out that two different types of people fly to Honolulu. Type A consists of business people with a demand of QA = 260 - 0.4P. Type B consists of students whose total demand is QB = 240 - 0.6P. Because the students are easy to spot, EA decides to charge them different prices. Graph each of these demand curves and their horizontal sum. What price does EA charge the students? What price does it charge other customers? How many of each type are on each flight?
  4. What would EA’s profit be for each flight? Would the airline stay in business? Calculate the consumer surplus of each consumer group. What is the total consumer surplus?
  5. Before EA started price discriminating, how much consumer surplus was the Type A demand getting from air travel to Honolulu? Type B? Why did total consumer surplus decline with price discrimination, even though total quantity sold remained unchanged?

Suppose that two competing firms, A and B, produce a homogeneous good. Both firms have a marginal cost of MC = \(50. Describe what would happen to output and price in each of the following situations if the firms are at (i) Cournot equilibrium, (ii) collusive equilibrium, and (iii) Bertrand equilibrium.

(a) Because Firm A must increase wages, its MC increases to \)80.

(b) The marginal cost of both firms increases.

(c) The demand curve shifts to the right.

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