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IAI Actuarial Core Principles · Business Economics · Pricing strategies in the financial services sector

A mutual fund house charges a lower expense ratio for large institutional investors than for retail investors, who are less price-sensitive. At each group's profit-maximising output, marginal revenue equals the same marginal cost. If retail demand is less elastic than institutional demand, what follows for the prices?

The retail price is higher. Setting marginal revenue equal to the same marginal cost in each segment means price is higher where demand is less elastic, so less price-sensitive retail investors pay more than the more elastic institutional investors.

  1. AThe retail price is higher than the institutional priceCorrect
  2. BThe retail price is lower than the institutional price
  3. CBoth prices are equal to marginal cost
  4. DBoth prices must be equal because marginal cost is the same
  5. The institutional price is higher because larger volumes raise costs

Explanation

MR = P(1 - 1/|e|). With equal MR across segments, the segment with the lower elasticity must have the higher price. Retail is less elastic, so its price is higher. Equal marginal cost does not imply equal prices.

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