MicroEconomics theory and application 12th by browning an zupan chapter 12

Prepared by Dr Della Lee Sue, Marist College MICROECONOMICS: Theory & Applications Chapter 12: Product Pricing with Monopoly Power By Edgar K Browning & Mark A Zupan John Wiley & Sons, Inc 12th Edition, Copyright 2015 Copyright © 2015 John Wiley & Sons, Inc All rights reserved Learning Objectives    Explain price discrimination, the various degrees of price discrimination, and how price discrimination can increase a firm’s profit Spell out the three necessary conditions for a firm to be able to engage in price discrimination Demonstrate how, under third-degree price discrimination, market segments that have less elastic demand end up being charged a higher price, all else being equal (continued) Copyright © 2015 John Wiley & Sons, Inc All rights reserved Learning Objectives    (continued) Show how intertemporal price discrimination, a type of third-degree price discrimination, can increase a firm’s profit Explore how two-part tariffs, a form of second-degree price discrimination, can increase a firm’s profit Explain the mathematics behind price discrimination Copyright © 2015 John Wiley & Sons, Inc All rights reserved Explain price discrimination, the various degrees of price discrimination, and how price discrimination can increase a firm’s profit 12.1 PRICE DISCRIMINATION Copyright © 2015 John Wiley & Sons, Inc All rights reserved Price Discrimination   Definition – the practice of charging different prices for the same product when there is no cost difference to the producer in supplying the product Why would a firm want to price discriminate?  To increase profit  To increase total surplus (consumer surplus plus producer surplus) Copyright © 2015 John Wiley & Sons, Inc All rights reserved Types of Price Discrimination  First-degree (perfect) price discrimination – a policy in which each unit of output is sold for the maximum price a consumer will pay  Second-degree price discrimination (block pricing) – the use of a schedule of prices such that the price per unit declines with the quantity purchased by a particular consumer  Third-degree price discrimination (market segmentation) – a situation in which each consumer faces a single price and can purchase as much as desired at that price, but the price differs among categories of consumers Copyright © 2015 John Wiley & Sons, Inc All rights reserved First-Degree (Perfect) Price Discrimination  The price schedule is tailored to each consumer: all units are priced at the maximum price each consumer will pay  MR curve coincides with the demand curve  The profit-maximizing output level is efficient  The monopolist makes the maximum profit given the demand curve  The monopolist captures all of the consumer surplus as profit  Implementation: monopolist needs to determine what consumer is willing to pay Copyright © 2015 John Wiley & Sons, Inc All rights reserved Figure 12.1 - Price Discrimination Can Increase Profit Copyright © 2015 John Wiley & Sons, Inc All rights reserved Second-Degree Price Discrimination (Block Pricing)  Consumers are charged a different price for different quantities, with the schedule of prices set to extract the entire consumer surplus  Price per unit declines with the quantity purchased by a particular consumer  The same price schedule confronts all consumers  Monopolist captures the consumer surplus as profit Copyright © 2015 John Wiley & Sons, Inc All rights reserved Figure 12.2 - Second-Degree Price Discrimination: Block Pricing Copyright © 2015 John Wiley & Sons, Inc All rights reserved 10 Figure 12.4 - Price and Output Determination Under Price Discrimination Copyright © 2015 John Wiley & Sons, Inc All rights reserved 18 Show how intertemporal price discrimination, a type of third-degree price discrimination, can increase a firm’s profit 12.4 INTERTEMPORAL PRICE DISCRIMINATION AND PEAK-LOAD PRICING Copyright © 2015 John Wiley & Sons, Inc All rights reserved 19 Intertemporal Price Discrimination  Definition: a form of third-degree price discrimination in which different market segments are willing to pay different prices depending on the time at which they purchase the good  MC is constant  Profit-maximizing output in each segment is where MR=MC  Price can be set up to the amount indicated by the demand curve for that segment Copyright © 2015 John Wiley & Sons, Inc All rights reserved 20 Figure 12.5 - Intertemporal Price Discrimination Copyright © 2015 John Wiley & Sons, Inc All rights reserved 21 Peak-Load Pricing  Definition: a pricing policy in which different prices are charged for peak and off-peak periods  MC is not constant  Price is set where SMC intersects the demand curve  Advantages:  A more efficient distribution of usage between the peak and offpeak periods results  The required capacity during peak demand is less than that required under uniform pricing, resulting in a cost saving Copyright © 2015 John Wiley & Sons, Inc All rights reserved 22 Figure 12.6 - Peak-Load Pricing Copyright © 2015 John Wiley & Sons, Inc All rights reserved 23 Explore how two-part tariffs, a form of second-degree price discrimination, can increase a firm’s profit 12.5 TWO-PART TARIFFS Copyright © 2015 John Wiley & Sons, Inc All rights reserved 24 Two-Part Tariffs  Definition: a form of second-degree price discrimination in which a firm charges consumers a fixed fee per time period for the right to purchase the product at a uniform per-unit price  Entry fee – the fixed fee charged per time period  Average price falls as larger quantity is purchased  Conditions:  Firm must have monopoly power  Resale of product must be preventable Copyright © 2015 John Wiley & Sons, Inc All rights reserved 25 Figure 12.7 – A Two-Part Tariff Copyright © 2015 John Wiley & Sons, Inc All rights reserved 26 Many Consumers, Different Demands  When consumers have different demand curves, a different entry fee must be charged to each consumer  Constraint: difficult to determine demand curve and consequently the profit-maximizing entry fee  When demands differ, firm has incentive to alter both the entry fee and the price  Effect: price is usually lower than simple monopoly price Copyright © 2015 John Wiley & Sons, Inc All rights reserved 27 Figure 12.8 – A Two-Part Tariff with Different Demands Copyright © 2015 John Wiley & Sons, Inc All rights reserved 28 Why the Price Will Usually Be Lower Than the Monopoly Price  Because an entry fee coupled with a price that is lower than the uniform price that would be charged by a simple monopoly will increase profit  Conclusions:  A firm can increase profit using this pricing strategy  The price charges will be lower than a simple monopoly price but higher than marginal cost  Output will be higher than under a simple monopoly and the deadweight loss will be smaller Copyright © 2015 John Wiley & Sons, Inc All rights reserved 29 Figure 12.9 - Effect of a Two-Part Tariff on Price Copyright © 2015 John Wiley & Sons, Inc All rights reserved 30 Explain the mathematics behind price discrimination 12.6 THE MATHEMATICS BEHIND PRICE DISCRIMINATION* *Denotes digital-only content Copyright © 2015 John Wiley & Sons, Inc All rights reserved 31 The Mathematics behind Price Discrimination  Goal: maximize profit  Profit-maximizing condition:  Price will be lower in the market with the more elastic demand curve since: Copyright © 2015 John Wiley & Sons, Inc All rights reserved 32 ... 26 Many Consumers, Different Demands  When consumers have different demand curves, a different entry fee must be charged to each consumer  Constraint: difficult to determine demand curve and. .. charged for peak and off-peak periods  MC is not constant  Price is set where SMC intersects the demand curve  Advantages:  A more efficient distribution of usage between the peak and offpeak... they purchase the good  MC is constant  Profit-maximizing output in each segment is where MR=MC  Price can be set up to the amount indicated by the demand curve for that segment Copyright