Lecture Microeconomics (5th edition): Chapter 12 - Capturing surplus. This chapter presents the following content: Introduction - airline tickets; price discrimination: first degree, second degree, third degree; tie-in sales.
Chapter 12 Copyright (c)2014 John Capturing Surplus Chapter Twelve Overview Introduction: Airline Tickets Price Discrimination • First Degree • Second Degree • Third Degree Copyright (c)2014 John Tie-in Sales • Requirements Tie-ins • Package Tie-ins (Bundling) Chapter Twelve Uniform Price Vs Price Discrimination While the monopolist captures profits due to an optimal uniform pricing policy, it does not receive the consumer surplus or dead-weight loss associated with this policy The monopolist can overcome this by charging more than one price for its product Definition: A monopolist price discriminates if it charges more than one price for the same good or service Chapter Twelve Copyright (c)2014 John Definition: A monopolist charges a uniform price if it sets the same price for every unit of output sold Forms of Price Discrimination Definition: A policy of second degree price discrimination allows the monopolist to offer consumers a quantity discount Definition: A policy of third degree price discrimination offers a different price for each segment of the market (or each consumer group) when membership in a segment can be observed Chapter Twelve Copyright (c)2014 John Definition: A policy of first degree (or perfect) price discrimination prices each unit sold at the consumer's maximum willingness to pay This willingness to pay is directly observable by the monopolist “Willingness to Pay” Curve Think of the demand curve as a "willingness to pay" curve If the monopolist can observe the willingness to pay of each customer (based on, for example, residence, education, "look", etc), then the monopolist can observe demand perfectly and can "perfectly" price discriminate Chapter Twelve Copyright (c)2014 John Definition: The consumer's maximum willingness to pay is called the consumer's reservation price Forms of Price Discrimination Copyright (c)2014 John Definition: A policy of first degree (or perfect) price discrimination prices each unit sold at the consumer's maximum willingness to pay This willingness to pay is directly observable by the monopolist Chapter Twelve Uniform Price Vs Price Discrimination Uniform Price Monopoly 1st Degree P.D Monopoly Price CS: PS: TS: DWL: E+F G+H+K+L E+F+G+H+J+K+L+N E+F+G+H+K+L E+F+G+H+J+K+L+N J+N H G P1 K Copyright (c)2014 John PU E F MC J N L MR D Quantity Chapter Twelve Is it Reasonable? Buying a Car Therefore, a perfectly price discriminating monopolist will produce and sell the efficient quantity of output Note: Only if the monopolist can prevent resale can the monopolist capture the entire surplus Chapter Twelve Copyright (c)2014 John The monopolist will continue selling units until the reservation price exactly equals marginal cost Pricing Surplus – Monopoly MC = P = 20 - Q What is producer surplus if uniform pricing is followed? Copyright (c)2014 John MR = P + ( P/ Q)Q = 20 - Q - Q = 20 - 2Q MR = MC => 20 - 2Q = => Q* = P* = 11 PS= Revenue-TVC = PQ-2Q = 11(9)-2(9) = 81 Chapter Twelve Pricing Surplus – Monopoly P = MC => 20 - Q = =>Q* = 18 Revenue - TVC = [18(20-2)(1/2) + 18(2)]-18(2) = 162 This is a gain in captured surplus of 81! Chapter Twelve 10 Copyright (c)2014 John What will producer surplus be if the monopolist perfectly price discriminates? If the monopolist could set a different block price for each customer, it would capture the same amount of surplus as a perfectly price discriminating monopolist Chapter Twelve 22 Copyright (c)2014 John Block Pricing Utility Pricing D - large Copyright (c)2014 John D - small MC Chapter Twelve 23 Q Utility Pricing D - large Additional CS P1 Additional PS P2 MC Q1s Q1L Q2L Chapter Twelve Q 24 Copyright (c)2014 John D - small Third Degree Price Discrimination Example: Movie ticket sales to older people or students at discount • Suppose that marginal costs for the two markets are the same How does a monopolist maximize profit with this type of price discrimination? Chapter Twelve 25 Copyright (c)2014 John Definition: A policy of third degree price discrimination offers a different price for each segment of the market (or each consumer group) when membership in a segment can be observed Optimal Pricing This implies that MR1 = MC = MR2 at the optimum Otherwise, the monopolist could raise revenues by switching sales from the low MR group to the high MR group MC = AC = 20 P1 = 100 - Q1 P2 = 80 - 2Q2 Chapter Twelve 26 Copyright (c)2014 John Set the marginal revenue in each market equal to marginal cost (i.e., the monopolist maximizes total profits by maximizing profits from each group individually.) Optimal Pricing MR1 = 100 - 2Q1 = MC = 20 MR2 = 80 - 4Q2 = MC = 20 Copyright (c)2014 John Q1* = 40 Q2* = 15 P1* = 60 P2* = 50 Chapter Twelve 27 Third Degree Price Discrimination 100 Market Demand 80 60 Market Demand 50 20 MR1 100 Q Chapter Twelve 20 40 MR2 Q 28 Copyright (c)2014 John P P Tie-in Sales – Requirements • Requirements tie-in sales occur when a firm requires customers who buy one product from the firm to buy another product from the firm A requirements tie-in sale may be used in place of price discrimination when the firm cannot observe the relative willingness to pay of different customers Chapter Twelve 29 Copyright (c)2014 John Definition: A tie-in sale occurs if customer can buy one product only if they agree to purchase another product as well Tie-in Sales – Bundling Package tie-in sales (or bundling) occur when goods are combined so that customers cannot buy either good separately Copyright (c)2014 John • Bundling may be used in place of price discrimination to increase producer surplus when consumers have different willingness to pay for the goods sold in the bundle But bundling does not always pay… Chapter Twelve 30 Tie-in Sales – Bundling Negatively Correlated Preferences Computer Monitor Customer 1 $1,200 $600 Customer 2 $1,500 $400 Marginal Cost $1,000 $300 Chapter Twelve Copyright (c)2014 John Reservation Price 31 Tie-in Sales – Bundling Optimal Pricing Policy • Copyright (c)2014 John Without bundling: pc = $1500 pm = $600 Profit cm = $800 With bundling: pb = $1800 • Profit b = $1000 Chapter Twelve 32 Tie-in Sales – Bundling Positively Correlated Preferences Computer Monitor Customer 1 $1,200 $400 Customer 2 $1,500 $600 Marginal Cost $1,000 $300 Chapter Twelve Copyright (c)2014 John Reservation Price 33 Tie-in Sales – Bundling Optimal Pricing Policy Without bundling: pc = $1500 pm = $600 Profit cm = $800 With bundling: pb = $2100 • Profit b = $800 In general, bundling a pair of goods only pays if their demands are negatively correlated (customers who are willing to pay relatively more for good A are not willing to pay as much for good B) Chapter Twelve 34 Copyright (c)2014 John • Reservation Price Copyright (c)2014 John The reason is that the price is determined by the purchaser with the lowest reservation price If reservation prices for the two goods are negatively correlated, bundling reduces the dispersion of reservation prices and so raises the price at which additional units can be sold Chapter Twelve 35 Advertising Copyright (c)2014 John The firm can capture surplus using nonprice strategies such as advertising Chapter Twelve 36 ... p2(Q2)(Q2-Q1) - TC(Q2) Copyright (c)2014 John = (100 - Q1)Q1 + (100 - Q2)(Q2-Q1) - 10Q2 and we must choose Q1 and Q2 to maximize this profit… MR1 = (100 - Q1) - Q1 - (100 - Q2) = MR2 = (100 - Q2) -. .. - Q - Q = 20 - 2Q MR = MC => 20 - 2Q = => Q* = P* = 11 PS= Revenue-TVC = PQ-2Q = 11(9 )-2 (9) = 81 Chapter Twelve Pricing Surplus – Monopoly P = MC => 20 - Q = =>Q* = 18 Revenue - TVC = [18(2 0-2 )(1/2)... Pricing D - large Copyright (c)2014 John D - small MC Chapter Twelve 23 Q Utility Pricing D - large Additional CS P1 Additional PS P2 MC Q1s Q1L Q2L Chapter Twelve Q 24 Copyright (c)2014 John D - small