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Monopoly Part 2

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Pricing with Market Power Price Discrimination First Degree Price Discrimination Second Degree Price Discrimination Third Degree Price Discrimination

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AR, AC, P Q D = AR MC MR Q1Q1 M P1P1 Q2Q2 Q3Q3 T N P3P3 P2P2 O Capturing Consumer Surplus

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AR, AC, P Q D = AR MC MR Q1Q1 M P1P1 Q2Q2 Q3Q3 T N P3P3 P2P2 O First degree price discrimination reservation price

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AR, AC, P Q D = AR MC MR Q1Q1 M P1P1 Q2Q2 T P2P2 O D E C F B A

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Exercise Suppose a monopolist has a constant marginal cost MC = 2. The firm faces the demand curve P = 20 – Q. There are no fixed cost. Suppose a monopolist has a constant marginal cost MC = 2. The firm faces the demand curve P = 20 – Q. There are no fixed cost. Suppose price discrimination is not allowed. How large will the producer surplus be? Suppose the firm can engage in perfect first degree price discrimination. How large will be producer surplus be?

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AR, AC, P Q D = AR Q1Q1 M P2P2 Q2Q2 T P3P3 O N P1P1 Q3Q3 Second degree price discrimination block pricing

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AR, AC, P Q D = AR MC MR Q0Q0 M P0P0 Q1Q1 Q3Q3 T N P3P3 P1P1 O AC Q2Q2 P2P2 R

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Third degree price discrimination A firm must have some market power to price discrimination The firm must have some information about the different amounts people will pay for its product A firm must be able to prevent resale, or arbitrage MR 1 = MR 2 = MC

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Q P Q P MC D1D1 MR 1 D2D2 MR 2

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Exercise Suppose a railroad faces the following demand for coal movement P c = 38 – Q c Where Q c is the amount of coal moved when the transport price for coal is P c. The railroad’s demand for grain movement is P G = 14 – 0.25Q G where Q G is the amount of grain shipped when the transport price for grain is P G. The marginal cost for moving either commodity is 10. Suppose a railroad faces the following demand for coal movement P c = 38 – Q c Where Q c is the amount of coal moved when the transport price for coal is P c. The railroad’s demand for grain movement is P G = 14 – 0.25Q G where Q G is the amount of grain shipped when the transport price for grain is P G. The marginal cost for moving either commodity is 10. What are the profit maximizing rates for coal and grain movement?

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Intertemporal Price Discrimination Q P DtDt D t+1 MR t+1 MR t QtQt PtPt Q t+1 P t+1

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Peak – Load Pricing Q P D2D2 D1D1 MR 1 MR 2 Q2Q2 P2P2 Q1Q1 P1P1 MC

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Peak – Load Pricing & Welfare Q P D2D2 D1D1 Q2Q2 P2P2 Q1Q1 P1P1 MC P Q1*Q1* Q2*Q2*

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Two Part Tariff Q P MCP Usage FeeEntry Fee

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Two Part Tariff Q P MCB D2 D1 A P T Q2Q1 C Profit = 2T + ( P – MC )(Q1 + Q2 ) Two Consumers

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Bundling ThreeVENUS 10,000 A 12,000 3,000 4,000 B ThreeVENUS 10,000 A 12,000 4,000 3,000 B Negative correlated Positive correlated

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Separated price Buy Both Buy only good 2 Buy only good 1 Buy neither P2P2 P1P1 R1R1 R2R2

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Bundled price Buy Both Buy neither P2P2 P1P1 R1R1 R2R2 R 2 = P B – R 1

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Bundled price Buy Both Buy neither P2P2 P1P1 R1R1 R2R2 R 2 = P B – R 1

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Bundled price Buy Both Buy neither P2P2 P1P1 R1R1 R2R2 R 2 = P B – R 1

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Advertising MR Adv = full Marginal cost of Ad.

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Advertising to sale ratio

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Transfer Pricing No Outside Market Division 1 Division 2 Division X Q 2, P 2 Q 1, P 1 Q, P Firm X Q = f ( K, L, Q 1, Q 2 )

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For Firm

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Race Car Motors has the following demand for automobile P = 20,000 – Q MR = 20,000 – 2Q Downstream division cost of assembling cars is C A ( Q ) = 8000Q MC A = 8000 The upstream division cost of producing engines is C E ( Q E ) = 2Q E 2 MC E ( Q E ) = 4Q E Race Car Motors has the following demand for automobile P = 20,000 – Q MR = 20,000 – 2Q Downstream division cost of assembling cars is C A ( Q ) = 8000Q MC A = 8000 The upstream division cost of producing engines is C E ( Q E ) = 2Q E 2 MC E ( Q E ) = 4Q E Exercise

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Monopsony Monopsony is a market consisting of single buyer that can purchase from many sellers. Some buyers may have Monopsony power : a buyer’s ability to affect the price of a good. Monopsony power enables the buyer to purchase the good for less than the price that would prevail in the competitive market

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Competitive Buyer & Competitive Seller AR, P Q D = MV MC AR, P Q ME = AE P*P* Q*Q* Q*Q* AR = MR

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Monopsonist Buyer AR, AC, P MV ME QMQM PMPM QCQC S = AE PCPC

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AR, AC, P MV ME QMQM PMPM QCQC S = AE PCPC AR, AC, P AR MR QMQM PMPM QCQC MC PCPC Monopoly and Monopsony

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AR, AC, P MV ME Q* P* S = AE MV ME Q* MV – P* S = AE P* MV – P*

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Source of Monopsony Power The Elasticity of Market Supply The Number of Buyer The Interaction among Buyers

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AR, AC, P MV ME QMQM PMPM QCQC S = AE PCPC A B C Deadweight Loss

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McGraw-Hill/Irwin Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. MONOPOLY MONOPOLY Chapter 12.

McGraw-Hill/Irwin Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. MONOPOLY MONOPOLY Chapter 12.

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