1. 1 Chapters 12: Product Pricing with Monopoly Power

2. 2 Price Discrimination Price discrimination is the practice of charging different prices in different markets for the same basic product Price discrimination is practiced as a method to maximizing total profit by charging prices that are closest to the highest that each customer (market) are willing to pay Perfect price discrimination (first degree price discrimination) occurs if monopolist is able to charge exactly what each consumer is willing to pay SMC ATC D Q 1 Q 2 Q 3 P1P1 P2P2 P3P3 Economic Profit

3. 3 Three Necessary Conditions for Price Discrimination 1.Some degree of market power 2.Seller must have some means of approximating what different buyers are willing (the maximum) to pay for each unit of output 3.Seller must be able to prevent resale (or arbitrage) of the product

4. 4 Algebra of Monopoly Optimums with Perfect Price Discrimination A monopolist faces the following demand and marginal cost curves If the firm can perfectly price discriminate, what is the price it will charge the person with the lowest willingness to pay? What is the total profit? Profit Condition: Demand = MR = MC 200-Q/5 = 40, Q = 800, P = $40 Profit = 1/2 *(160*800) = $64,000

5. 5 Algebra of Monopoly Optimums with Segmented Markets A firm sells its product in two distinct markets with two distinct demand curves. Total output is currently 1500 units, with 1000 sold in Market 1 and 500 sold in Market 2. P 1 =12.00 - 1/500Q 1 = 12.00 - (1/500) * 1000 = $10.00 P 2 =16.00 - 3/250Q 2 = 16.00 - (3/250) * 500 = $10.00 Total Revenue = 10.00 * 1000 + 10.00 * 500 = $15,000 MR 1 =12.00 - (1/250)Q 1 MR 2 =16.00 - (3/125)Q 2 1500 = Q 1 + Q 2 Q 2 = 1500 - Q 1 MR 1 = MR 2 12.00 - (1/250)Q1 = 16.00 - (3/125)(1500 - Q 1) 32 = (7/250)Q 1 Q 1 = 1143 Q 2 = 357 P 1 = 12.00 - (1/500) * 1143 = $9.71P 2 = 16.00 - (3/250) * 357 = $11.72 Total Revenue = 9.71 * 1143 + 11.72 * 357 = $15,283

6. 6 Intertemporal Price Discrimination & Peak-Load Pricing Output Dollars per unit SMC A Q2Q2 Q’ 2 Q’ 1 Q1Q1 P1P1 P2P2 P D1D1 D2D2

7. 7 Intertemporal Price Discrimination & Peak-Load Pricing A utility changes its pricing scheme for electricity: Was: 6.7 cents/kWh at all hours –7,000 kWh/day during off-peak hours and 20,000 kWh/day during peak hours –Total Cost: (20,000 + 7,000) * 6.7 = $1,809 Now: 7.3 cents/kWh peak and 4.8 cents/kWh off-peak –5,000 kWh/day shift from peak to off-peak use –Peak hours cost: 15,000 * 7.3 = $1,095 –Off-peak hours cost: 12,000 * 4.8 = $576 –Total Cost: 1,095 + 576 = $1,671