Perfect competition vis-à-vis monopolies A Brief Summary of what we know

PC: In the long-run In the long run, the firm will make only normal (accounting) profit (zero economic profit). Its horizontal demand curve will touch its average total cost curve at its lowest point

The Monopolist’s Profit Image: Animated Figure 10.3 Lecture notes: Remember that the demand function represents willingness to pay (WTP) of consumers. At the quantity q, the monopolist charges a price equal to the height of the demand, or equal to the WTP of the consumers at that quantity. Recall the area of a rectangle is length * height. Here, the length of the green profit rectangle is the number of units the monopoly sells. The height of the rectangle is average profit per unit. Thus, we get the following formula from the graph: Total profit = (number of units sold) * (average profit per unit)

Deadweight Loss of Monopoly Image: Animated Figure 10.5 Lecture notes: From text: The monopolist charges too high a price and produces too little of the product, so some consumers who would benefit from a competitive market lose out. Since the demand curve, or the willingness to pay, is greater than the marginal cost between output levels QM and QC, society would be better off if output was expanded to QC. But a profit-maximizing monopolist will limit output to QM. The result, a deadweight loss equal to the area of the yellow triangle, is inefficient for society.

The Problems with Monopoly Monopolies can make societies worse off Restricting output and charging higher prices compared to competitive markets Operate inefficiently (deadweight loss). This is referred to as market failure. Less choices for consumers Unhealthy competition called “rent seeking” Lecture notes: The word “monopoly” often has a negative connotation. With a bad economy, we often hear people complaining about “greedy companies,” “Wall Street,” “banks”, etc. However, these entities are often not monopolies. Monopolies are often economically inefficient. This comes from the fact that P > MC and that output is restricted compared to competitive markets.

And then there’s price discrimination Price Discrimination – Different ways of extracting Consumer’s Surplus Charging Same Customer Different Price for Each Unit of the Good Extracts Consumer Surplus from single price for all units Requires firm to know each customer’s demand curve Need to prevent resale Easier for food than for durable items Easier before eBay

And then there’s price discrimination Price Discrimination – Different ways of extracting Consumer’s Surplus Charging Different Customers Different Price for Same Good Extracts Consumer Surplus from single price for all units Requires firm to know each customer’s demand curve Need to prevent resale Geographic separation – e.g., Madison Park gas station

Measuring consumer surplus with the demand curve 2 Measuring consumer surplus with the demand curve (a) Price = $80 (b) Price = $70 $100 80 70 50 Price of Albums $100 80 70 50 Price of Albums Demand Demand John’s consumer surplus ($30) John’s consumer surplus ($20) Paul’s consumer surplus ($10) Total consumer surplus ($40) 4 3 1 2 Quantity of Albums 4 3 1 2 Quantity of Albums In panel (a), the price of the good is $80, and the consumer surplus is $20. In panel (b), the price of the good is $70, and the consumer surplus is $40.

Price Discrimination Lessons from perfect price discrimination Rational strategy Increase profit Charges each customer a price closer to his or her willingness to pay Sell more than is possible with a single price

Second-Degree Price Discrimination Second-degree price discrimination occurs when firms sell their product at a discount when consumers buy large quantities. Example: Electricity prices? Costco/Sam’s Club – “Big Box Stores” http://www.amosweb.com/cgibin/awb_nav.pl?s=wpd&c=dsp& k=second-degree+price+discrimination

Third-Degree Price Discrimination Under third-degree price discrimination, a firm charges different prices in different markets for their product. The most common form of price discrimination Examples include: Children's discounts Senior citizen’s discounts Airfares Different geographic markets (Madison Park, U District)

More Complex Monopoly Pricing Schemes Classic categorization of monopolies 3 levels of price discrimination First degree (Perfect Price Discrimination) Extract almost all of the Consumer Surplus Able to get a different price for each unit sold Moves consumer along the Demand Curve Second degree Provide quantity discounts; but have to buy in blocks, with each larger block having a lower price than the last Third degree Different prices for same good in different markets In all cases, it is necessary to prevent resale and new entrants

Third Degree Price Discrimination Choose Qs based MR = MC for market demand Set price for each segment Equating MC(market) to MR for each segment Setting price for Qs (segment) Zone pricing Gas stations? Grocery stores? Senior citizen discounts?

Third Degree Price Discrimination Setting separate prices in each market http://www.nowsell.com/marketing-guide/price-discrimination.html

To Be Able to Do Price Discrimination To be a successful price discriminator, a seller must satisfy three conditions: (1) to have market control and be a price maker, (2) to identify two or more groups that are willing to pay different prices, and (3) to keep the buyers in one group from reselling the good to another group.

A Word from the FTC on Discriminatory Pricing A seller charging competing buyers different prices for the same "commodity" or discriminating in the provision of "allowances" -- compensation for advertising and other services -- may be violating the Robinson-Patman Act. This kind of price discrimination may hurt competition by giving favored customers an edge in the market that has nothing to do with the superior efficiency of those customers. However, price discriminations generally are lawful, particularly if they reflect the different costs of dealing with different buyers or result from a seller’s attempts to meet a competitor’s prices or services.