Solution:

Multiple Product Pricing:

• The price theory or microeconomic models of price determination are based on the assumption that a the firm produces a single, homogeneous product.

• In actual practice, however, production of a single homogeneous product by a firm is an exception rather than a rule. Almost all firms have more than one product in their line of production.

• Even the most specialized firms produce a commodity in multiple models, styles and sizes, each so much differentiated from the other that each model or size of the product may be considered a different product.

• For example, the various models of refrigerators, TV sets, radios, and car models produced by the same company may be treated as different products for at least pricing purpose.

• The major problem in pricing multiple products is that each product has a separate demand curve. But, since all of them are produced under one organization by interchangeable production facilities, they have only one inseparable marginal, cost curve.

• That is, while revenue curves, AR and MR, are separate for each product, cost curves, AC and MC, are inseparable.

• Therefore, the marginal rule of pricing cannot be applied straight away to fix the price of each product separately. The problem, however, has been provided with a solution by E.W. Clements.

• The solution is similar to the one employed to illustrate third-degree price discrimination. As a discriminating monopoly tries to maximize its revenue in all its markets so do a multi-product firm in respect of each of its products.

• To illustrate the multiple product pricing, let us suppose that a firm has four different products A, B, C, and D in its line of production.

• The AR and MR curves for the four goods are shown in four segments of the Diagram The marginal cost for all the products taken together is shown by

• The marginal cost for all the products taken together is shown by the curve MC, which is the factory marginal cost curve.

• Let us suppose that when the MRS for the individual products is horizontally summed up, the aggregate MR (not given in the figure) passes through point C on the MC curve.

• If a line parallel to the X-axis is drawn from point C to the Y-axis through the MRS, the intersecting points will show the points where MC and Mrs are equal for each product, as shown by the line EMR, the Equal Marginal Revenue line.

• The points of intersection between EMRs and Mrs determine the output level and price for each product. The output of the four products is given as OQ1 of product A; Q1Q2 of B; Q2Q3 of C; Q3Q4 of D. The respective prices for the four products are P1Q1 for product A; P2Q2 for B; P3Q3 for C, and P4Q4 for D.

• This price and output combinations maximize the profit from each product and hence the overall profit of the firm.