Chapter 25 Monopoly Behavior

25.1 Price Discrimination Price discrimination: selling different units of output at different prices. First-degree price discrimination  Different units of output for different prices.  Price schedules differ from person to person.  Prices differ across quantities as well as consumers.

25.1 Price Discrimination Second-degree price discrimination  Different units of output for different prices.  Same price for the same quantity.  Prices differ across quantities, but not across consumers. Third-degree price discrimination  Different prices for different consumers.  Same price for the same consumer.  Prices differ across consumers, but not across quantities.

25.2 First-degree Price Discrimination Discrete good Reservation prices r 1 =v(1)-v(0) r 2 =v(2)-v(1) r 3 =v(3)-v(2) Gross Consumer’s surplus r 1 + r 2 + r 3 =v(3)-v(0)

25.2 First-degree Price Discrimination Price of the 1 st unit: r 1  ΔCS: zero  ΔPS: r 1 -MC Price of the 2 nd unit: r 2  ΔCS: zero  ΔPS: r 2 -MC Price of the 3 rd unit: r 3  ΔCS: zero  ΔPS: r 3 -MC Can charge v(3) for the first three units  ΔCS: zero  ΔPS: v(3)-3*MC

25.2 First-degree Price Discrimination To consumer 1  Sell 8 units  Charge v 1 (8) To consumer 2  Sell 3 units  Charge v 2 (3)

25.2 First-degree Price Discrimination Each unit of the good is sold at the reservation price. No consumer’s surplus generated. The output is Pareto efficient.

25.2 First-degree Price Discrimination To consumer 1  Sell x 1 0 units  Charge v 1 (x 1 0 ) To consumer 2  Sell x 2 0 units  Charge v 2 (x 2 0 )

25.3 Second-degree Price Discrimination Two consumers: high demand and low demand. The firm cannot identify the consumers. Zero marginal cost assumed for simplicity. Screening: price-quantity packages that give the consumers an incentive to choose the right package meant for them.  Two contracts: (x H, p H ), (x L, p L ).  The high demand selects (x H, p H ).  The low demand selects (x L, p L ).

25.3 Second-degree Price Discrimination Full information case Low demand  x L =x 1 0, p L =A High demand  x H =x 2 0, p H =A+B+C

25.3 Second-degree Price Discrimination Self-selection High demand will choose (x L, p L ) and get B. x H =x 2 0, p H =A+C

25.3 Second-degree Price Discrimination Adjustment Low demand  x L =x 1 m, p L =A High demand  x H =x 2 0, p H =A+C+D+E New profit: E-D

25.3 Second-degree Price Discrimination Optimum Low demand  x L =x 1 m, p L =A High demand  x H =x 2 0, p H =A+C+D

EXAMPLE: Price Discrimination in Airfares High demand and low demand: business and non-business travelers. Restricted fare  Advanced purchase, inconvenient hours, but cheap.  Designed for low demand. Unrestricted fare  Fully flexible but expensive.  Designed for high demand.

25.4 Third-degree Price Discrimination Two groups of consumers. The firm is able to identify the consumers. Constant unit price for each market. The good cannot be resold. Firm’s problem

25.4 Third-degree Price Discrimination F.O.C.: MR 1 (y 1 )=MC(y 1 +y 2 ) MR 2 (y 2 )=MC(y 1 +y 2 ) or

25.4 Third-degree Price Discrimination |  2 (y 2 )| > |  1 (y 1 )|: p 1 >p 2 The market with the higher price must have the lower elasticity of demand.

25.5 Bundling Bundles: packages of related goods offered for sale together. Willingness to pay for software components Type of consumerWord processorSpreadsheet Type A consumers Type B consumers

25.5 Bundling Selling software separately  Charge $100 for each software.  Total revenue: $400. Bundling  Charge $220 for the software suite.  Total revenue: $440. Diversity in consumers’ willingness to pay lowers the price one can charge. Bundling reduces this diversity.

25.6 Two-Part Tariffs People go to Disneyland for rides. Two prices  Admission ticket: t  Price of rides: p* Given p*, t=CS Profits from rides: (p*-MC)x* Optimal price: p*=MC

25.7 Monopolistic Competition Product differentiation  Products are similar, but not identical.  Coca-Cola and Pepsi-Cola. Monopolistic competition  Each firm faces a downward-sloping demand curve for its product.  Free entry into the industry.  Monopolists with zero profits.

25.7 Monopolistic Competition Monopolistic competition  The demand curve and the average cost curve must be tangent with each other.