How Much Should You Charge?

Through Coyote Blog and Cafe Hayek, an interesting reminder on "marginal cost pricing":

When you teach microeconomics, one of the topic students find it hard to convert to is that of marginal cost pricing. Indeed, they usually have a hard time understanding why firms should set their price equal to their marginal cost in order to maximize their profit. They may not be all that wrong after all! In 1946, Ronald Coase, a Nobel Prize Winner, wrote an article which he entitled "The Marginal Cost Controversy". Coase was urging economists to mitigate their absolute faith in marginal cost pricing. His main line of resasoning is the following:

"Economists: loose your devotion to marginal-cost pricing. The best prices are not necessarily those that equal marginal cost. Prices above marginal cost help convey important information – namely, information about the value of the capital invested that makes provision of the good or service possible in the first place. This information, in turn, is important to entrepreneurs searching for profitable places to invest their money and energies. "

Coase's point is even more significant in today's knowledge (inspiration) economies as we have tried to show in two earlier post on this blog (here and here).

May be your best bet next time you teach marginal cost pricing to your students will be to start with cases where it does not apply. Fairly good chances they gonna listen to you carefully especially if you use Kazaa, Napster and intellectual property as examples!