chapter 11 pricing with market power

Chapter 11 Slide 6Capturing Consumer Surplus •A: consumer surplus with P* •B: P>MC & consumer would buy at a lower price •P 1 : less sales and profits •P 2 : increase sales & and reduc

Chapter 11

Pricing with Market Power

Pricing with Market Power

 Pricing without market power (perfect competition) is determined by market supply and demand

 The individual producer must be able to forecast the market and then

concentrate on managing production (cost) to maximize profits

Chapter 11 Slide 4

Introduction

 Pricing with market power (imperfect

competition) requires the individual producer to know much more about the characteristics of demand as well as

manage production

Capturing Consumer Surplus

$/Q

D

MR

P max

MC If price is raised above

P*, the firm will lose sales and reduce profit.

P C

P C is the price that would exist in

Between 0 and Q*, consumers

will pay more than P* consumer surplus (A).

B

P 2

Beyond Q*, price will

have to fall to create a

consumer surplus (B).

Chapter 11 Slide 6

Capturing Consumer Surplus

•A: consumer surplus with P*

•B: P>MC & consumer would buy

at a lower price

•P 1 : less sales and profits

•P 2 : increase sales & and reduce

revenue and profits

•P C: competitive price

Quantity

$/Q

D MR

Capturing Consumer Surplus

in A and sell profitably in B?

Answer Price discrimination Two-part tariffs

Chapter 11 Slide 8

Capturing Consumer Surplus

 Price discrimination is the charging of different prices to different consumers for similar goods

Price Discrimination

 First Degree Price Discrimination

willing to pay.

Additional Profit From Perfect

First-Degree Price Discrimination

Consumer surplus is the area above P* and between

Q** (purple)

Q**

P C

Q**

P C

With perfect discrimination

• Each customer pays their

reservation price

•Profits increase

Additional Profit From Perfect

First-Degree Price Discrimination

Chapter 11 Slide 12

 Question

achieving first-degree price discrimination?

 Answer

1) Too many customers (impractical)

2) Could not estimate the reservation

price for each customer

Additional Profit From Perfect

First-Degree Price Discrimination

 Practice of charging different prices per unit for different quantities of the same good or service

Second-Degree Price Discrimination

Second-Degree Price Discrimination

Quantity

$/Q

D MR

MC AC

P 0

Q 0

Without discrimination: P = P 0 and Q = Q 0 With second-degree discrimination there are three prices P 1 , P 2 , and P 3 (e.g electric utilities)

Second-Degree Price Discrimination

$/Q

D MR

MC AC

Economies of scale permit:

•Increase consumer welfare

•Higher profits

Chapter 11 Slide 16

Price Discrimination

 Third Degree Price Discrimination

1) Divides the market into two-groups.2) Each group has its own demand

function

Third-Degree Price Discrimination

MR T

MR T = MR 1 + MR 2

•Group 1: P 1 Q 1 ; more inelastic

•Group 2: P 2 Q 2 ; more elastic

•MR 1 = MR 2 = MC

Q 1

P 1

MC = MR 1 = MR 2

Intertemporal Price

Discrimination and Peak-Load Pricing

 Separating the Market With Time

inelastic

 Book

Chapter 11 Slide 20

 Separating the Market With Time

profit, firms lower the price to appeal to a general market with a more elastic demand

Intertemporal Price Discrimination

Chapter 11 Slide 22

 Demand for some products may peak at particular times

Intertemporal Price

Discrimination and Peak-Load Pricing

Peak-Load Pricing

 Capacity restraints will also increase

Chapter 11 Slide 24

 MR is not equal for each market

because one market does not impact the other market

Peak-Load Pricing

Intertemporal Price

Discrimination and Peak-Load Pricing

Chapter 11 Slide 26

The Two-Part Tariff

 The purchase of some products and services can be separated into two decisions, and therefore, two prices

The Two-Part Tariff

Chapter 11 Slide 28

The Two-Part Tariff

 Pricing decision is setting the entry

fee (T) and the usage fee (P).

 Choosing the trade-off between

free-entry and high use prices or high-free-entry and zero use prices

Usage price P*is set where

than twic more

) (

) (



  T  P  MC x Q Q

P*

The Two-Part Tariff

 The Two-Part Tariff With Many Different Consumers

entry fee T* and the use fee P*.

profit with lower price and more entrants.

Chapter 11 Slide 32

The Two-Part Tariff

 The Two-Part Tariff With Many Different Consumers

several combinations of P,T.

profit.

The Two-Part Tariff

Chapter 11 Slide 34

Summary

 Firms with market power are in an enviable position because they have the potential to earn large profits, but realizing that potential may depend critically on the firm’s pricing strategy.

 A pricing strategy aims to enlarge the

customer base that the firm can sell to, and capture as much consumer surplus as

possible.

End of Chapter 11

Pricing with Market Power

Pricing with Market Power