Monopoly & Price Discrimination Hall & Lieberman, Chapter 9

Price Discrimination Single-price monopoly Firm that is limited to changing same price for each unit of output sold Price discrimination occurs when a firm charges different prices to different customers for reasons other than differences in costs Price-discriminating monopoly does not discriminate based on prejudice, stereotypes, or ill-will toward any person or group Rather, it divides its customers into different categories based on their willingness to pay for good

Requirements for Price Discrimination Although every firm would like to practice price discrimination, not all of them can To successfully price discriminate, three conditions must be satisfied Must be a downward-sloping demand curve for the firm’s output Firm must be able to identify consumers willing to pay more Firm must be able to prevent low-price customers from reselling to high-price customers

Price Discrimination That Harms Consumers Price discrimination always benefits owners of a firm Can use this ability to increase its profit When price discrimination raises price for some consumer above price they would pay under a single-price policy it harms consumers Additional profit for the firm is equal to monetary loss of consumers

Figure 8a: Price Discrimination Number of Round-trip Tickets Dollars per Ticket MC E ATC $120 80 MR D 30

Figure 8b: Price Discrimination Dollars per Ticket Additional profit from price discrimination MC $160 120 MR D Number of Round-trip Tickets 10 30

Figure 8c: Price Discrimination Dollars per Ticket MC Additional profit from price discrimination $120 F G 100 H MR D Number of Round-trip Tickets 30 30

Price Discrimination That Benefits Consumers Price discrimination benefits monopoly at the same time it benefits a group of consumers Since no one’s price is raised, no one is harmed by this policy When price discrimination lowers price for some consumers below what they would pay under a single-price policy, it benefits consumers as well as firm

Perfect Price Discrimination Suppose a firm could somehow find out maximum price customers would be willing to pay for each unit of output it sells It could increase profits even further by practicing perfect price discrimination Firm charges each customer the most the customer would be willing to pay for each unit he or she buys Increases profit at expense of consumers Perfect price discrimination is very difficult to practice in the real world Would require firm to read its customers’ minds Marginal revenue is equal to price of additional unit sold Firm’s MR curve is same as its demand curve

Figure 9: Perfect Price Discrimination Number of Dolls per Day Dollars per Doll E 20 $30 25 10 30 60 J B MC = ATC H D MR MR curve before price discrimination

The Decline of Monopoly? Past century was not kind to monopolies Today, monopolies face a different threat Relentless advance of technology The world of monopolies is changing rapidly But monopolies in many forms will be with us for some time

Using the Theory: Price Discrimination at Colleges and Universities Most colleges and universities give some kind of financial aid to a large proportion of their students Financial aid has been used as an effective method of price discrimination Designed to increase revenue of the college Colleges have long been in an especially good position to benefit from price discrimination, because they satisfy all three requirements Face downward-sloping demand curves Able to identify consumers willing to pay more Able to prevent low-price customers from reselling to high-price customers

Using the Theory: Price Discrimination at Colleges and Universities Most colleges have been active price discriminators for decades Under newer systems, those who can signal a lower willingness to pay have benefited from reduced prices While those signaling greater willingness to pay have suffered a price increase Result is vastly different prices for different students Highly correlated to their families’ willingness to pay Increased price discrimination at colleges, like so many other economic issues, is a matter of tradeoffs