PRICING POLICIES AND THE FIRM IN A SPATIAL MARKET: AN APPLICATION TO RETAIL FERTILIZER
Abstract
A firm marketing a single product (or enterprise within a multi-product firm) having delivery operations in addition to its in-plant operations is providing both a good and a service to its geographically distributed buyers. The product, in this case, anhydrous ammonia, may be considered to be a homogeneous product regardless of who buys it. However, the delivery service is not a homogeneous product if the cost of resources used in delivering a product is functionally related to delivery distance and volume delivered, and if the buyers are located at varying distances from the seller's location. When an individual buyer's demand for the product is functionally related to delivered price, and the cost of delivery is significantly different for variations in delivery distance, then the method of pricing the delivery service becomes important to both sellers and buyers. A fundamental question arises: What is the impact of alternative delivery service pricing policies on the firm's long-run equilibrium volume, market area, and costs? The objectives of this research included the study of alternative pricing policies for the competitive firm in a spatial market and the development of an analytical model of such a firm. The model was developed in the context of the anhydrous ammonia retail enterprise. The analytical model developed included spatial cost and spatial aggregate demand functions. Separate variables were incorporated in the model to represent delivery charge per ton and delivery charge per ton-mile which may or may not equal, respectively, the marginal cost per ton and marginal cost per ton-mile of delivery operations. It was assumed that the firm determined its short run profit maximizing price given knowledge of its demand and cost functions and its predetermined delivery service pricing policy. Equilibrium was determined by solving for the price-radius combination at which long-run profits were zero. The results indicated that alternative pricing policies do have an impact on the equilibrium price, the size of firm and its market area, and the average cost of processing and delivering a product. Also, the firm's expectation of rival firms' reactions to a change in his own price had a significant impact on the equilibrium solutions. Cost and demand data were developed for an anhydrous ammonia retail plant. The results of the empirical analysis of this data under alternative pricing policies, demand density patterns, and competitive price responses indicated that: (1) When the competitive price response was assumed to be close to one (i.e., dP/dP +1), discriminatory pricing, where delivery charge per ton-mile was less than variable delivery cost per ton-mile, resulted in lower average delivered price, higher volume of sales, and larger market areas in the long run. (2) The discriminatory pricing policy described in (1) resulted in less equitable distribution of delivery costs among spatially dispersed buyers. Near-by buyers subsidized delivery to more distant buyers. (3) A decreasing demand density pattern with respect to distance from the plant location generally lead to higher average delivery costs. The results of this study also indicated that future applications of this approach should be preceded by empirical studies of, among other things, competitive price response function of firms in a spatial market and the factors which may help explain the decreasing demand density pattern in such markets.
Degree
Ph.D.
Subject Area
Agricultural economics
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