Peak-load pricing involves charging lower prices for goods and services during off-peak times when demand is lower, in order to encourage consumers to shift some consumption to those off-peak times. This makes more efficient use of production capacity and reduces costs for producers. Examples include phone companies charging less for calls at night and on weekends, and airlines charging higher fares during popular travel seasons. The strategy shifts some demand away from peak times and leads to more efficient capacity utilization.

1. Peak-Load Pricing
When demand is not evenly distributed, a firm needs to have
facilities to accommodate periods of high demand.
Even with large facilities, the firm may experience times when
the demand is greater than can be handled. Then the firm
may experience costly computer system crashes.
During off-peak times (periods of lower demand), there is
excess capacity.
The firm charges less at off-peak times.
Example: More phone calls are made during business hours
than in the evenings and on weekends. So the phone
companies charge more during business hours.

2. Peak load pricing
• The effect of peak-load pricing is to induce some
consumption to shift, away from the times of
• peak demand, and toward times of lower
demand. Consumers are rewarded -- in the sense
that they pay
• less -- for using the service when there is ample
unutilised capacity, rather than when demand
takes up
• or even exceeds all the capacity. This makes for
more efficient use of existing capacity.

3. Peak load pricing
• Telephone service providers, for
instance, charges a lower call rate from 11:00
pm to 6:00am. Long distance calls made
during off-peak periods also cost less. Some
“decongestion” results from this practice.
• The same outcome happens when airlines
charge higher fares during the tourist season.

4. Peak load pricing
• This shifting of consumption creates what economists
call “efficiency gains.” If airfares were kept uniform,
airlines would forego profits because they have to turn
away passengers when flights are fully booked, while
other flights take off with a lot of empty seats.
• The “average” price has the effect of encouraging
higher consumption during peak periods and lower
consumption during off-peak periods -- which
producers and consumers don’t really want.

5. Peak load pricing
• The high demand at certain hours would
compel the producers to install additional
capacity. Producers would have to pump in
additional capital, and pass the cost on to
consumers. However, the increased capacity
becomes even more under-utilized during the
off-peak hours.

6. Peak load pricing
• The effect of peak-load pricing is to induce some
consumption to shift, away from the times of
peak demand, and toward times of lower
demand. Consumers are rewarded -- in the sense
that they pay less -- for using the service when
there is ample unutilised capacity, rather than
when demand takes up or even exceeds all the
capacity. This makes for more efficient use of
existing capacity.

7. Two- Part Tariffs
• Two- Part Tariffs Consumers pay a one-time access fee
(T) for the right to buy a product, and a per-unit price
(P) for each unit they consume.
• Examples: Amusement parks, Golf Clubs, T-passes,
• Necessary conditions for Two-Part Tariff
implementation:
• Firm must have market power
• Firm must be able to control access
• Homogeneous consumer demand (all the consumers
within the same segment have the same demand
curve)

8. Example
• Some video game stores offer customers two
ways to rent cds:
• (i) Pay an annual membership fee (e.g., $40), and
then pay a small fee for the daily rental of each
film (e.g., $2 per film per day) (Two part Tariff)
• (ii) Pay no membership fee, but pay a higher daily
rental fee (e.g., $4 per game per day) (Simple
rental fee) Why might it be more profitable to
offer consumers a choice of two plans, rather
than a single plan for all customers?
•

9. Example
• A classic price discrimination example. The store
has created a menu of choices where each plan
appeals to a different group of consumers that
will self select into the option designed for them.
The high demand consumer will probably choose
the two-part tariff, while the casual consumer will
prefer the simple rental fee.
• Profits will be greater with price discrimination
than with a single pricing scheme for all
customers

10. The “Two-Part Tariff”
• There are two components to the price: a unit
price (P) for each unit consumed, & a “tariff”
(T) for entry into the market.
• Examples include telephone service, health
clubs, etc.
• The tariff enables the firm to capture some
consumer surplus.

11. Suppose that a firm has constant average and marginal costs as
shown.
Also, each customer has the indicated demand
curve.
Suppose that the firm charges price P* per unit.
P
Based on the per unit charge, the firm earns
revenues equal to the area of the blue box.
P*
ATC=MC
D
Q
Q*

12. The firm can also pick up the consumer surplus,
if it charges a membership fee equal
• P to the area of the green triangle.
P*
ATC=MC
D
Q
Q*

13. Bundling
• Bundling is packaging two or more products to
gain a pricing advantage.
• Conditions necessary for bundling to be the
appropriate pricing alternative:
• Customers are heterogeneous.
• Price discrimination is not possible.
• Demands for the two products are negatively
correlated.

14. Bundling
• Bundling Bundling refers to selling more than one
product at a single price.
• When is bundling applicable:
• The firm has market power
• Price discrimination is not possible (inability to
offer different prices to different customers or
segments)
• Demand for two or more goods to be sold is
negatively correlated (the more consumers
demand one good, the less they will demand of
the other good)

15. Types of bundling
• Pure Bundling: Consumers must buy both
goods together; the choice of buying one
good without buying the other is NOT given.
• Mixed Bundling: Consumers have the choice
of buying both goods or buying one good
without the other.

16. Consider the following reservations prices,
for two buyers: Alan and Beth
Sum of
Stereo TV reservation
prices
Alan $225 $375 $600
Beth $325 $275 $600
Maximum price for
$225 $275
both to buy the good
To get both people to buy both goods without bundling, you can
only charge $225 + $275 = $500, & each person would have
consumer surplus of $600 – $500 = $100.
If you bundle, you can charge $600 & consumer surplus = 0.

17. Transfer Pricing
• Sometimes firms are organized into separate
divisions.
• One division may produce an intermediate
product and supply it to another division to
produce the final product.
• How does the firm determine the efficient
price at which the intermediate product
should be sold. That is, what is the transfer
price?

18. The Simplest Case
• The firm has 2 divisions: E and A
• Division E produces the intermediate product (engine) for
Division A which produces the final product (automobile).
• Division E does not sell engines to anyone but division
A, and division A does not buy engines from anyone but
division E.
• Each unit of output (automobile) requires one unit of the
input (engine).
• The goal is to maximize the firm’s profit.

19. How do we determine the optimal quantity & price for the
final product (the auto)?
•First, find the company’s (total) marginal cost MCT, which is
the marginal cost of division E’s producing an engine (MCE)
plus the marginal cost of division A’s producing an auto
(MCA).
•That is, MCT = MCA + MCE .
•Then, produce the amount of output (autos) so that the
marginal revenue from selling an auto (MR) is equal to the
marginal cost of production (MCT).
•The appropriate price of the auto for that quantity of
output is determined from the demand curve for the firm’s
autos.

20. Transfer pricing
Transfer Price is:
the internal price charged by one segment of a firm for a
product or service supplied to another segment of the same
firm
Such as:
• Internal charge paid by final assembly division for
components produced by other divisions
• Service fees to operating departments for
telecommunications, maintenance, and services by support
services departments
20

21. Transfer Pricing
• The transfer price creates revenues for the
selling subunit and purchase costs for the
buying subunit, affecting each subunit’s
operating income
• Intermediate Product – the product or service
transferred between subunits of an
organization
21

22. Effects of Transfer Prices
Performance measurement:
• Reallocate total company profits among business
segments
• Influence decision making by purchasing, production,
marketing, and investment managers
Rewards and punishments:
• Compensation for divisional managers
Partitioning decision rights:
• Disputes over determining transfer prices
22

23. Three Transfer Pricing Methods
1. Market-based Transfer Prices
2. Cost-based Transfer Prices
3. Negotiated Transfer Prices
23

24. Market-Based Transfer Prices
• Top management chooses to use the price of a
similar product or service that is publicly
available. Sources of prices include trade
associations, competitors, etc.
24

25. Market-Based Transfer Prices
• Lead to optimal decision making when three
conditions are satisfied:
1. The market for the intermediate product is
perfectly competitive
2. Interdependencies of subunits are minimal
3. There are no additional costs or benefits to the
company as a whole from buying or selling in the
external market instead of transacting internally
25

26. Market-Based Transfer Prices
• A perfectly competitive market exists when there is a
homogeneous product with buying prices equal to selling
prices and no individual buyer or seller can affect those
prices by their own actions
• Allows a firm to achieve goal congruence, motivating
management effort, subunit performance evaluations,
and subunit autonomy
• Perhaps should not be used if the market is currently in a
state of “distress pricing”
26

27. Cost-Based Transfer Prices
• Top management chooses a transfer price based on the
costs of producing the intermediate product. Examples
include:
– Variable Production Costs
– Variable and Fixed Production Costs
– Full Costs (including life-cycle costs)
– One of the above, plus some markup
• Useful when market prices are
unavailable, inappropriate, or too costly to obtain
27

28. Negotiated Transfer Prices
• Occasionally, subunits of a firm are free to negotiate the
transfer price between themselves and then to decide
whether to buy and sell internally or deal with external
parties
• May or may not bear any resemblance to cost or market
data
• Often used when market prices are volatile
• Represent the outcome of a bargaining process between
the selling and buying subunits
28

29. Comparison of
Transfer-Pricing Methods
Criteria Market- Cost- Negotiated
Based Based
Achieves Goal Yes, when Often, but not Yes
Congruence markets are always
competitive
Useful for Yes, when Difficult unless Yes, but transfer
Evaluating Subunit markets are transfer price prices are affected
Performance competitive exceeds full cost by bargaining
strengths of the
buying and selling
divisions
29

30. Comparison of
Transfer-Pricing Methods
Criteria Market- Cost- Negotiated
Based Based
Motivates Yes Yes, when based on Yes
Management budgeted costs;
Effort less incentive to
control costs if
transfers are based
on actual costs
Preserves Subunit Yes, when No, because it is Yes, because it is
Autonomy markets are rule-based based on
competitive negotiations
between subunits
30

31. Comparison of
Transfer-Pricing Methods
Criteria Market- Cost- Negotiated
Based Based
Other Factors No market may Useful for Bargaining and
exist or determining negotiations
markets may full cost of take time and
be imperfect or products; easy may need to be
in distress to implement reviewed
repeatedly as
conditions
change
31

32. Minimum Transfer Price
• The minimum transfer price in many situations should
be:
Incremental cost per unit
Minimum incurred up to the point of Opportunity Cost per unit
Transfer Price = transfer + to the selling subunit
– Incremental cost is the additional cost of producing and
transferring the product or service
– Opportunity cost is the maximum contribution margin forgone
by the selling subunit if the product or service is transferred
internally
32

33. Transfer Pricing for International Taxation
When products or services of a multinational firm are transferred between segments
located in countries with different tax rates, the firm attempts to set a transfer price
that minimizes total income tax liability.
Segment in higher tax country:
Reduce taxable income in that country by charging high prices on imports and low
prices on exports.
Segment in lower tax country:
Increase taxable income in that country by charging low prices on imports and high
prices on exports.
33