1. 1 BEE2017BEE2017 Intermediate Microeconomics 2 Price and product discrimination Dieter Balkenborg Todd Kaplan BEE2017

2. 2 Timetable Lectures (Todd and Dieter): Lectures (Todd and Dieter): –Tuesday 12:00-13:00, STC/A –Thursday 16:00-17:00, STC/A Help Hour (Miguel Fonseca) Help Hour (Miguel Fonseca) –Tuesday 16:00-17:00, LAV/LT6 (starts next week) Experiments (Miguel + Pricilla Marimo + Sara Talloo) starts next week. Please sign up! Experiments (Miguel + Pricilla Marimo + Sara Talloo) starts next week. Please sign up! –Tuesday 11:00-12:00 STC/116. –Friday 10:00-11:00 STC/116.

3. 3 Textbooks Any modern intermediate microeconomics textbook is suitable. There are free ones available on the web! Any modern intermediate microeconomics textbook is suitable. There are free ones available on the web! In particular: Nicholson et al. In particular: Nicholson et al.

4. 4 Summative Assessment Exam in June 2 hours Exam in June 2 hours –85 marks Assignments Assignments –Aplia homework. Two per week starting next week: Two per week starting next week: One graded (after) and one not graded (before). One graded (after) and one not graded (before). Each counts equally towards 10 marks Each counts equally towards 10 marks –Classroom and Homework experiments: Do 5 experiments with short questionnaire for 5 marks. Experiments will rotated bi-weekly. You cannot repeat the same experiment. Priority to signups. Do 5 experiments with short questionnaire for 5 marks. Experiments will rotated bi-weekly. You cannot repeat the same experiment. Priority to signups.

5. 5 First assignment A homework experiment on the FEELE website A homework experiment on the FEELE website Access code: trk1-BEE2017a Access code: trk1-BEE2017a Details will be announced on www.toddkaplan.com follow link to Undergraduate Micro Details will be announced on www.toddkaplan.com follow link to Undergraduate Micro

6. 6 Topics Price discrimination (Todd) Price discrimination (Todd) Auctions (Todd) Auctions (Todd) Imperfect Competition (Todd+Dieter) Imperfect Competition (Todd+Dieter) Game theory (Dieter) Game theory (Dieter) Asymmetric Information (Dieter) Asymmetric Information (Dieter) General equilibrium and welfare theorems (Dieter) General equilibrium and welfare theorems (Dieter) Externalities and public goods (Dieter) Externalities and public goods (Dieter)

7. 7 Simple Monopolist Inverse demand is p=14-q and mc=2. Inverse demand is p=14-q and mc=2. Monopolist Profits=revenue-costs=(14-q)q-2q Monopolist Profits=revenue-costs=(14-q)q-2q Taking Derivative: Taking Derivative: Marginal Revenue-marginal costs=14-2q-2 Marginal Revenue-marginal costs=14-2q-2 This should equal zero. Thus, This should equal zero. Thus, Marginal Revenue=marginal costs Marginal Revenue=marginal costs 14-2q-2=12-2q=0 14-2q-2=12-2q=0 Monopolist produces q=6 and the price is p=14- 6=8. Monopolist profit is 36. Monopolist produces q=6 and the price is p=14- 6=8. Monopolist profit is 36. How does this look graphically? How does this look graphically?

8. 8 P=14-Q (inverse demand) MR Q M =6 P M =8 A B C MC=2 14 Consumer Surplus with monopoly: A Producer Surplus with monopoly:B Welfare loss with monopoly: C

9. 9 Price Discrimination Basic model: a monopolist charges: Basic model: a monopolist charges: A. Same price for all units. B. Same price to all customers. Changing one or both of these is called Price Discrimination. Can one profit from this? Changing one or both of these is called Price Discrimination. Can one profit from this? 1st degree is different prices for both consumers and units (both A and B are changed) 1st degree is different prices for both consumers and units (both A and B are changed) 2nd degree is different prices for different units (A changed). 2nd degree is different prices for different units (A changed). 3rd degree is different prices to different consumers (B changed). 3rd degree is different prices to different consumers (B changed).

10. 10 Homework Experiment An example to learn all three types of price discrimination An example to learn all three types of price discrimination Certainly relevant for the exam Certainly relevant for the exam max 15 min max 15 min Details on www.toddkaplan.com. Details on www.toddkaplan.com.www.toddkaplan.com Go to: FEELE, participant access Go to: FEELE, participant access Access code: trk1-BEE2017a Access code: trk1-BEE2017a

11. 11 1st-Degree Price Discrimination Different prices for both consumers and units. Different prices for both consumers and units. To do this properly, a monopolist must have strong information on: To do this properly, a monopolist must have strong information on: Consumers preferences. Consumers preferences. Who is who. Who is who. 1st degree captures the whole consumer surplus. 1st degree captures the whole consumer surplus. 1st degree is efficient. 1st degree is efficient.

12. 12 Effort to Discriminate In 1990, IBM introduced the LaserPrinter E. In 1990, IBM introduced the LaserPrinter E. The difference was that it printed 5 ppm rather than 10 ppm. The difference was that it printed 5 ppm rather than 10 ppm. They did so by ADDING 5 chips in the E model. The purpose of the chips was to make the printer WAIT. They did so by ADDING 5 chips in the E model. The purpose of the chips was to make the printer WAIT. The price of the new laserprinter E was 60% of the old one. The price of the new laserprinter E was 60% of the old one. Why did IBM pay for a reduction in the speed? Why did IBM pay for a reduction in the speed?

13. 13 Effort to Discriminate Model Jim values the faster printer at 1000 and the slower printer at 700. Jim values the faster printer at 1000 and the slower printer at 700. Sean values the faster printer at 700 and the slower printer at 600. Sean values the faster printer at 700 and the slower printer at 600. It costs 450 to make the faster printer and 475 to make the slower printer. It costs 450 to make the faster printer and 475 to make the slower printer. What should IBM charge for either printer? What should IBM charge for either printer? If IBM only sells the fast printer, what should it charge? If IBM only sells the fast printer, what should it charge? If IBM wants to sell the fast printer to Jim and the slow printer to Sean, what is the max/min price difference. If IBM wants to sell the fast printer to Jim and the slow printer to Sean, what is the max/min price difference. What happens if the fast printer is priced at 1000 and the slow printer 600? What happens if the fast printer is priced at 1000 and the slow printer 600?

14. 14 Other Examples of Effort to Discriminate Intel with its SX processors had the math coprocessor disabled. Intel with its SX processors had the math coprocessor disabled. Fast delivery service may hold back packages that are 2 nd day rather than overnight. Fast delivery service may hold back packages that are 2 nd day rather than overnight. Photo shops wont give you films in 1 hour even though they may be ready if you have ordered the longer service. Photo shops wont give you films in 1 hour even though they may be ready if you have ordered the longer service. Sony Minidisc 60 minute vs. 74 minute versions minidiscs are the same except for a code on the 60 minute version written to stop it from writing the longer time. Sony Minidisc 60 minute vs. 74 minute versions minidiscs are the same except for a code on the 60 minute version written to stop it from writing the longer time. Hard disks in MP3 players. Sometimes is cheaper to buy the MP3 player and take out the hard disk. People did this so they had to take precautions. Hard disks in MP3 players. Sometimes is cheaper to buy the MP3 player and take out the hard disk. People did this so they had to take precautions. Cameras with 7 Megapixels have 3 Megapixels disabled. Cameras with 7 Megapixels have 3 Megapixels disabled.

15. 15 2 nd degree Price Discrimination Ari values 1 umbrella at 10 pounds and has no need for another umbrella. Ari values 1 umbrella at 10 pounds and has no need for another umbrella. Jodi values 1 umbrella at 11 pounds and also values 2 umbrellas at 15 (together). Jodi values 1 umbrella at 11 pounds and also values 2 umbrellas at 15 (together). They each want to maximize the difference between their value and the price they pay. They each want to maximize the difference between their value and the price they pay. What is the maximum a monopolist with zero marginal cost could make charging the same price per umbrella? What is the maximum a monopolist with zero marginal cost could make charging the same price per umbrella? What is the max it could make charging a price for 1 and a special for two together? What is the max it could make charging a price for 1 and a special for two together? Hint: what would happen if they charge 10 for one and 15 for two? Hint: what would happen if they charge 10 for one and 15 for two?

16. 16 Movie Release Dates Studios want to maximize revenue. Studios want to maximize revenue. Consumers must decide when (if) to watch the film. Consumers must decide when (if) to watch the film. Consumers prefer seeing the film earlier but are willing to pay different amounts. Consumers prefer seeing the film earlier but are willing to pay different amounts. Some prefer different formats. Some prefer different formats.

17. 17 Movie Release: A simple model. There are only two formats: Theater and Home. There are only two formats: Theater and Home. The home release can be early or late. The studio gets £5 for each Theater sale and £2 for each home viewer. The home release can be early or late. The studio gets £5 for each Theater sale and £2 for each home viewer. Four Consumers. Four Consumers. A only wants to see the movie in the theater. A only wants to see the movie in the theater. B only wants to see the movie at home. B only wants to see the movie at home. C will see the movie in the theater if the release is late. Otherwise, C will see it at home. C will see the movie in the theater if the release is late. Otherwise, C will see it at home. D will see the movie at home only if only if the release is early. D will see the movie at home only if only if the release is early. What is studio profit for early? Late? What should the studio do? What is studio profit for early? Late? What should the studio do?

18. 18 Movie Release: further analysis After the studio announces release date and the movie is released, what should it do? After the studio announces release date and the movie is released, what should it do? What stops this from happening each time? Consumers judge the release date not by what the studio says, but by either previous record or what the studio has incentive to do. What stops this from happening each time? Consumers judge the release date not by what the studio says, but by either previous record or what the studio has incentive to do. Do you remember which studio produced the Titanic? Do you remember which studio produced the Titanic? If consumers judge the industry as a whole rather than individual studios, then what happens? If consumers judge the industry as a whole rather than individual studios, then what happens?

19. 19 International Pricing of Pharmaceutical Companies Prices of antipsychotic drug in various countries. Why such a difference?

20. 20 3rd-degree price discrimination There are two groups of people that make up total demand D(p)=D1(p)+D2(p). There are two groups of people that make up total demand D(p)=D1(p)+D2(p). Example: MC=0, D1(p)=100-p and D2(p)=60-p. Example: MC=0, D1(p)=100-p and D2(p)=60-p. q=D1(p)+D2(p)=160-2p. q=D1(p)+D2(p)=160-2p. We find p=80-q/2. Marginal revenue is 80-q. We find p=80-q/2. Marginal revenue is 80-q. MR=MC implies q=80 and p=40. MR=MC implies q=80 and p=40. Profit with one price is 3200. Profit with one price is 3200. MR in market 1 is 100-2*q1 and in market 2 is 60-2*q2. MR in market 1 is 100-2*q1 and in market 2 is 60-2*q2.

21. 21 3rd-degree price discrimination Find q1, q2, p1 and p2. Find q1, q2, p1 and p2. Show that combined profits are 2500+900=3400. Show that combined profits are 2500+900=3400. At home: Try the same for D1(p)=100-p and D2(p)=100-p. At home: Try the same for D1(p)=100-p and D2(p)=100-p. Need to ensure one group cant sell to another (leakage). Need to ensure one group cant sell to another (leakage). Companies try to prevent leakage and take advantage when it is limited: DVDs and camcorders (PAL vs. NTSC). Companies try to prevent leakage and take advantage when it is limited: DVDs and camcorders (PAL vs. NTSC).

22. 22 Examples of Price Discrimination. Book publisher having a cheap international edition of a book. Book publisher having a cheap international edition of a book. How about paperbacks. How about paperbacks. Publisher charging libraries a higher rate to libraries than to individuals. Publisher charging libraries a higher rate to libraries than to individuals. Frequent Flyer Programs. Frequent Flyer Programs. First Class Train tickets. First Class Train tickets. Saturday stayover for airfares. Saturday stayover for airfares.

23. 23 Two-Part Tariffs The sports center charges a fee to join and then a per usage fee. The sports center charges a fee to join and then a per usage fee. Definition: A two-part tariff is a per unit fee, r, plus a lump sum fee, F. Why dont they just charge one or the other to make it simple? Why dont they just charge one or the other to make it simple? This charges demanders of a low quantity a lower average price than demanders of a high quantity. What form of price discrimination (if any) is this? What form of price discrimination (if any) is this? This is also the case with video games such as the Xbox. This is also the case with video games such as the Xbox. Electric toothbrushes Electric toothbrushes

24. 24 Other two-part pricing Example: IBM and its punch cards (overpriced). Example: IBM and its punch cards (overpriced). There are three types of consumers. There are three types of consumers. –A is a heavy user and will make calculations all day long: needs 100 punch cards. –B is a light user and will need to make calculations only at the end of the day: needs 50 punch cards. –C is a hobbyist and would only fool around with the machine: needs 5 punch cards. The value of each calculation (using one card) is £100 (over the year). C values owning the machine at £1000. The machine costs £3000 to produce and punch cards £0. The value of each calculation (using one card) is £100 (over the year). C values owning the machine at £1000. The machine costs £3000 to produce and punch cards £0.

25. 25 Two-part tariff: punch cards What is the monopolys profits if it charges 0 for each punch card, r=0? What is the monopolys profits if it charges 0 for each punch card, r=0? What happens if the monopoly charges 0 for the machine and only for the punch cards, F=0? What happens if the monopoly charges 0 for the machine and only for the punch cards, F=0? What happens if the monopoly charges £1500 for the machine and £70 for each punch card? (F=1500,r=70) What happens if the monopoly charges £1500 for the machine and £70 for each punch card? (F=1500,r=70)

26. 26 Other comments Sometimes there too high transaction costs for two-part tariffs: Disneyland dilemma. Sometimes there too high transaction costs for two-part tariffs: Disneyland dilemma. Two-part tariffs could also be used for surplus extraction rather than discrimination. Two-part tariffs could also be used for surplus extraction rather than discrimination. Example all customers are identical and have demand: – –P = 14 - Q – –MC = AC=2

27. 27 Example: Surplus Extraction w/ Two-Part Tariff 14 Q P 2 12 72 Optimal two-part tariff: (1) maximize surplus by r =2. (2) set F=surplus=72. Why? Note: Used in Franchises

28. 28 Bundling Two types of people: A values $120 for Word, $100 for Excel. A values $120 for Word, $100 for Excel. B values $100 for a Word, $120 for Excel. B values $100 for a Word, $120 for Excel. Microsoft has zero marginal cost. If Microsoft charges separately for each program, it can make $200 for each software product for a total of $400. They could package both together (and stop selling it individually) and sell it for $220 making a total profit of $440.

29. 29 Anti-Competitive Bundling A library has £10,000 to spend on journals. There are 10 good journals out there. They want to buy as many journals as they can for the budget as long as each journal is less than £2000. Six journals are owned by one publisher -E. The 4 independent journals cost £1000 each. What is the maximum the E can make if it charges a separate price for each (assume marginal cost is zero)? How about if E bundles all 6 together? If E bundles all together, what can the independent journals do?