Chapter 25 Monopoly Behavior

25.1 Price Discrimination

Price discrimination: selling different units of output at different prices.

First-degree price discriminationDifferent 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

r1=v(1)-v(0)

r2=v(2)-v(1)

r3=v(3)-v(2) Gross Consumer’s

surplus

r1+ r2+ r3=v(3)-v(0)

25.2 First-degree Price Discrimination Price of the 1st unit: r1

ΔCS: zero ΔPS: r1-MC

Price of the 2nd unit: r2 ΔCS: zero ΔPS: r2-MC

Price of the 3rd unit: r3 ΔCS: zero ΔPS: r3-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 v1(8)

To consumer 2 Sell 3 units Charge v2(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 x1

0 units Charge v1(x1

0)

To consumer 2 Sell x2

0 units

Charge v2(x20)

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: (xH, pH), (xL, pL).The high demand selects (xH, pH).The low demand selects (xL, pL).

25.3 Second-degree Price Discrimination Full information

case Low demand

xL=x10, pL=A

High demandxH=x2

0, pH=A+B+C

25.3 Second-degree Price Discrimination Self-selection High demand

will choose (xL, pL) and get B.

xH=x20, pH=A+C

25.3 Second-degree Price Discrimination Adjustment Low demand

xL=x1m, pL=A

High demandxH=x2

0, pH=A+C+D+E

New profit: E-D

25.3 Second-degree Price Discrimination Optimum Low demand

xL=x1m, pL=A

High demandxH=x2

0, pH=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

1 21 1 1 2 2 2 1 2

,max ( ) ( ) ( )y y

p y y p y y c y y

25.4 Third-degree Price Discrimination F.O.C.:

MR1(y1)=MC(y1+y2)

MR2(y2)=MC(y1+y2)

or

1 1 1 21 1

1( ) 1 ( )

( )p y MC y y

y

2 2 1 22 2

1( ) 1 ( )

( )p y MC y y

y

25.4 Third-degree Price Discrimination

|2(y2)| > |1(y1)|: p1>p2

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 consumer Word processor Spreadsheet

Type A consumers 120 100Type B consumers 100 120

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 differentiationProducts are similar, but not identical.Coca-Cola and Pepsi-Cola.

Monopolistic competitionEach 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.