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Price skimming

Price skimming is a pricing strategy in which a marketer sets a relatively high price for a product or service at first, then lowers the price over time. It is a temporal version of price discrimination/yield management.

Price Skimming

It allows the firm to recover its sunk costs quickly before competition steps in and lowers the market price.

Price skimming is sometimes referred to as riding down the demand curve. This can be seen in the series of diagrams on the right.The first diagram shows the demand schedule, price, and quantity demanded at time t=1.

Additional short run demand schedules representing times t=2 and t=3 are added in subsequent diagrams.

As time goes by, price decreases and volume increases.

When the 3 equilibria are joined we obtain the price skimmersí long run demand schedule (shown in green).

The objective of a price skimming strategy is to capture the consumer surplus (the area in blue, between the single market clearing price (P*) and the highest price charged (P1)). If this is done successfully, then theoretically no customer will pay less for the product than the maximum they are willing to pay. In practice it is impossible for a firm to capture all of this surplus.

Limitations of Price Skimming

There are several potential problems with this strategy. Price changes by any one firm will be matched by other firms resulting in a rapid growth in industry volume. Dominant market share will typically be obtained by a low cost producer that pursues a penetration strategy.

See also : pricing, marketing, microeconomics, production, costs, and pricing, penetration pricing, price discrimination

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