QUESTION
An established company has private information about its marginal cost; the potential entrant does not know exactly what that cost is but they do know it is either very low, low, or average with probabilities 0.1, 0.3, and 0.6 respectively. The established company chooses either a high price, a moderate price, or a competitive price (pH > pM > pC ) and is able to commit to that choice. The entrant can enter or not after observing the chosen price.
Carefully and clearly write down appropriate posterior beliefs for
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Carefully and clearly write down appropriate posterior beliefs for (a) a separating strategy in which the price set is proportional to the marginal cost; (b) a pooling strategy; and (c) a semiseparating strategy in which low and very low cost firms choose a competitive price while average cost firms choose a moderate one
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(a) a separating strategy in which the price set is proportional to the marginal cost;
(b) a pooling strategy; and
(c) a semiseparating strategy in which low and very low cost firms choose a competitive price while average cost firms choose a moderate one
ANSWER
Posterior Beliefs for Pricing Strategies in Economic Markets
Introduction
In economic markets, firms employ different pricing strategies to maximize their profits and gain a competitive advantage. This essay discusses and provides appropriate posterior beliefs for three distinct pricing strategies: separating strategy with proportional pricing to marginal cost, pooling strategy, and semiseparating strategy with tiered pricing based on cost levels. Understanding these strategies can provide insights into firms’ decision-making processes and their potential impact on market dynamics.
Separating Strategy with Proportional Pricing to Marginal Cost
In this strategy, firms set their prices proportional to their marginal costs. The posterior beliefs associated with this approach are as follows:
Efficiency and Market Competition
Firms adopting a separating strategy based on proportional pricing to marginal cost are likely to be operating in a highly competitive market environment. This strategy suggests that firms aim to achieve market efficiency by aligning their pricing closely with their production costs.
Price-Quality Relationship
Customers may form a posterior belief that the quality of products or services offered by firms employing this strategy is directly proportional to their prices (Customer Expectations, n.d.). Lower prices may be perceived as an indication of lower quality, while higher prices may signal superior quality.
Cost Leadership
Firms with lower marginal costs have a comparative advantage in this strategy as they can offer products or services at relatively lower prices. Consequently, customers may develop a belief that firms employing this strategy with lower prices possess a cost leadership position in the market.
Pooling Strategy
The pooling strategy involves firms adopting a uniform pricing approach regardless of their cost structures. The posterior beliefs associated with this strategy can be summarized as follows:
Market Homogeneity
Customers may infer that firms using a pooling strategy offer products or services that are similar in terms of quality and value, irrespective of differences in their cost structures. This strategy suggests that firms prioritize market homogeneity over cost differentials.
Brand Perception
Firms employing a pooling strategy may focus on building strong brand perceptions and customer loyalty, as they cannot differentiate themselves through pricing. Customers may develop a belief that these firms invest heavily in marketing, innovation, or other differentiating factors to create value beyond price.
Consumer Trust
The pooling strategy may engender trust among customers, as they expect consistent quality and pricing from all firms adopting this approach. Customers may perceive the absence of price discrimination as fair and equitable treatment, reinforcing their trust in these firms.
Semiseparating Strategy with Tiered Pricing
In the semiseparating strategy, firms with different cost structures choose distinct pricing levels. Low and very low-cost firms adopt competitive pricing, while average-cost firms choose a moderate pricing level (I. Team, 2020). The posterior beliefs associated with this strategy are as follows:
Cost-Quality Perception
Customers may associate lower-priced products or services offered by low and very low-cost firms with lower quality. Conversely, moderate-priced offerings from average-cost firms may be perceived as providing a balance between quality and affordability.
Market Segmentation
The semiseparating strategy suggests that firms target different customer segments based on their cost structures. Customers may develop a belief that low-cost firms cater to price-sensitive customers, while average-cost firms target a broader customer base seeking a balance between price and quality.
Differentiation and Value
The semiseparating strategy allows firms to differentiate themselves based on their cost structures and pricing levels (Bergh et al., 2014). Customers may perceive low-cost firms as offering cost advantages, while average-cost firms may provide additional value or benefits beyond price, such as improved customer service or unique features.
Conclusion
Pricing strategies play a crucial role in shaping market dynamics and influencing customer perceptions. The appropriate posterior beliefs associated with each strategy are critical for firms to understand as they formulate their pricing decisions. The separating strategy based on proportional pricing to marginal cost emphasizes market competition and cost leadership, while the pooling strategy focuses on market homogeneity and brand perception. The semiseparating strategy with tiered pricing capitalizes on cost-quality perceptions and market segmentation. By considering these posterior beliefs, firms can align their pricing strategies with customer expectations and gain a competitive edge in their respective markets.
References
Bergh, D. D., Connelly, B. L., Ketchen, D. J., & Shannon, L. M. (2014). Signalling Theory and Equilibrium in Strategic Management Research: An Assessment and a Research Agenda. Journal of Management Studies, 51(8), 1334–1360. https://doi.org/10.1111/joms.12097
Customer Expectations. (n.d.). StudySmarter UK. https://www.studysmarter.co.uk/explanations/business-studies/business-operations/customer-expectations/
Team, I. (2020). Competitive Pricing: Definition, Examples, and Loss Leaders. Investopedia. https://www.investopedia.com/terms/c/competitive-pricing.asp