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

Learning Objectives Explain price discrimination, the various degrees of price discrimination, and how price discrimination can increase a firm’s profit..  Demonstrate how, under third

MICROECONOMICS: Theory & Applications

By Edgar K Browning & Mark A Zupan

John Wiley & Sons, Inc.

12 th Edition, Copyright 2015

Chapter 12: Product Pricing with Monopoly Power

Prepared by Dr Della Lee Sue, Marist College

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)

Learning Objectives (continued)

 Show how intertemporal price discrimination, a type of

third-degree price discrimination, can increase a firm’s

12.1 PRICE DISCRIMINATION

Explain price discrimination, the various degrees of price discrimination, and how price discrimination can increase a firm’s profit.

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)

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

First-Degree (Perfect) Price

Discrimination

the maximum price each consumer will pay.

Figure 12.1 - Price Discrimination Can Increase Profit

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

Figure 12.2 - Second-Degree Price

Discrimination: Block Pricing

Third-Degree Price Discrimination

(Market Segmentation)

 The price differs among categories of consumers

 Examples:

 Faculty discounts at the college bookstore

 Telephone companies charging different monthly rates for business customers than for residential customers

 Movie theaters charging different prices for a matinee showing than for an evening showing

12.2 THREE NECESSARY CONDITIONS FOR PRICE DISCRIMINATION

Spell out the three necessary conditions for a firm to be able to engage in price discrimination.

Three Necessary Conditions for Price

Discrimination

1. The product seller must possess some degree of monopoly

power; that is, a downward-sloping demand curve

2. The seller must have some means of approximating the

maximum amount buyers are willing to pay for each unit

of output

3. The seller must be able to prevent resale or arbitrage of the

product among the market segments

12.3 PRICE AND OUTPUT

DETERMINATION WITH PRICE

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.

Price Determination

Increase total revenue by charging a higher price

to the market segment with the more inelastic

demand

Figure 12.3 – Gains from Price

Discrimination

Output Determination

Question: What level of output is most profitable?

 Common value of MR = horizontally sum of the

separate MR curves for each segment

 Guideline: Divide sales between market segments by

comparing the common value of MR with MC

Figure 12.4 - Price and Output Determination Under Price Discrimination

12.4 INTERTEMPORAL PRICE

DISCRIMINATION AND PEAK-LOAD

Show how intertemporal price discrimination, a type of third-degree price discrimination, can increase a firm’s profit.

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

segment.

Figure 12.5 - Intertemporal Price

Discrimination

Peak-Load Pricing

 Definition: a pricing policy in which different prices are charged for

peak and off-peak periods

off-peak periods results.

Figure 12.6 - Peak-Load Pricing

12.5 TWO-PART TARIFFS

Explore how two-part tariffs, a form of second-degree price

discrimination, can increase a firm’s profit.

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

Figure 12.7 – A Two-Part Tariff

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

Figure 12.8 – A Two-Part Tariff with

Different Demands

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

Figure 12.9 - Effect of a Two-Part Tariff

on Price

12.6 THE MATHEMATICS BEHIND

PRICE DISCRIMINATION*

Explain the mathematics behind price discrimination.

The Mathematics behind Price