Presentation on theme: "By Walter Y. Oi Presented by Sarah Noll. Charge high lump sum admission fees and give the rides away? OR Let people into the amusement park for free and."— Presentation transcript:
By Walter Y. Oi Presented by Sarah Noll
Charge high lump sum admission fees and give the rides away? OR Let people into the amusement park for free and stick them with high monopolistic prices for the rides?
A discriminating two-part tariff globally maximizes monopoly profits by extracting all consumer surpluses. A truly discriminatory two-part tariff is difficult to implement and would most likely be illegal.
Disneyland establishes a two-part tariff where the consumer must pay a lump sum admission fee of T dollars for the right to buy rides at a price of P per ride. Budget Equation: XP+Y=M-T [if X>0] Y=M[if X=0] M -is income Good Ys price is set equal to one Maximizes Utility by U=U(X,Y) subject to this budget constrain
Consumers demand for rides depends on the price per ride P, income M, and the lump sum admission tax T X=D(P, M-T) If there is only one consumer, or all consumers have identical utility functions and incomes, the optimal two-part tariff can easily be determined. Total profits: Π= XP+T-C(X) C(X) is the total cost function
In a market with many consumers with varying incomes and tastes a discriminating monopoly could establish an ideal tariff where: P=MC and is the same for all consumers Each consumer would be charged different lump sum admission tax that exhausts his entire consumer surplus This two-part tariff is discriminatory, but it yields Pareto optimality
Option 1 was the best option for Disneyland, sadly (for Disney) it would be found to be illegal, the antitrust division would insist on uniform treatment of all consumers. Option 2 presents the legal, optimal, uniform two-part tariff where Disney has to charge the same lump sum admission tax T and price per ride P
There are two consumers, their demand curves are ψ1 and ψ2 When P=MC, CS 1 =ABC and CS 2 =ABC Lump sum admission tax T cannot exceed the smaller of the CS No profits are realized by the sale of rides because P=MC
Profits can be increased by raising P above MC For a rise in P, there must be a fall in T, in order to retain consumers At price P, Consumer 1 is willing to pay an admission tax of no more than ADP The reduction in lump sum tax from ABC to ADP results in a net loss for Disney from the smaller consumer of DBE The larger consumer still provides Disney with a profit of DDEB As long as DDEB is larger than DBE Disney will receive a profit
Setting Price below MC Income effects=0 Consumer 1 is willing to pay a tax of ADP for the right to buy X1*=PD rides This results in a loss of CEDP Part of the loss is offset by the higher tax, resulting in a loss of only BED Consumer 2 is willing to pay a tax of ADP The net profit from consumer 2 is EBDD As long as EBDD> BED Disney will receive a profit
Pricing below MC causes a loss in the sale of rides, but the loss is more than off set by the higher lump sum admissions tax
A market of many consumers Arriving at an optimum tariff in this situation is divided into two steps: Step 1: the monopolist tries to arrive at a constrained optimum tariff that maximizes profits subject to the constraint that all N consumers remain in the market Step 2: total profits is decomposed into profits from lump sum admission taxes and profits from the sale of rides, where marginal cost is assumed to be constant.
Profits from lump sum admission taxes, πA=nT Profits from the sale of rides, πS=(P-c)X MC is assumed to be constant The elasticity of the number of consumers with respect to the lump sum tax is determined by the distribution of consumer surpluses
The pricing policy used by IBM is a two-part tariff The lessee must pay a lump sum monthly rental of T dollars for the right to buy machine time IBM price structure includes a twist to the traditional two-part tariff Each lessee is entitled to demand up to X* hours at no additional charge If more than X* hours are demanded there is a price k per additional hour
Profits from Consumer 1= (0AB)- (0CDB) Profit from Consumer 2= (0AB)- (0CDX*)+(DEFG) The first X* cause for a loss, but the last X2-X* hours contribute to IBMs profits