Lecture Microeconomics: Chapter 12 - Besanko, Braeutigam

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 Twelve Overview

1. Introduction: Airline Tickets

Uniform Price Vs Price Discrimination

Definition: A monopolist charges a uniform

price if it sets the same price for every unit of

output sold.

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 C

Forms of Price Discrimination

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

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

“Willingness to Pay” Curve

Definition: The consumer's maximum

willingness to pay is called the consumer's reservation

price.

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

Forms of Price Discrimination

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.

MC P1

MR

Quantity

Uniform Price Monopoly 1st Degree P.D Monopoly

Uniform Price Vs Price Discrimination

Is it Reasonable?

Buying a CarThe monopolist will continue selling units until

the reservation price exactly equals marginal

cost

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 Copyr

Pricing Surplus – Monopoly

Pricing Surplus – Monopoly

What will producer surplus be if the monopolist perfectly price discriminates?

P = MC => 20 - Q = 2 =>Q* = 18

Revenue - TVC = [18(20-2)(1/2) + 18(2)]-18(2) = 162

This is a gain in captured surplus of Cop

First Degree Price Discrimination

What is the marginal revenue curve for a perfectly price discriminating monopolist?

When the monopolist sells an additional unit, it does not have to reduce the price on the other units it is selling Therefore, MR

= P (i.e., the marginal revenue curve equals the demand curve.)

Definition: A policy of second degree

monopolist to charge a different price to different consumers While different consumers pay different prices, the reservation price of any one consumer cannot be directly observed

Second Degree Price Discrimination

Two Part Tariff

Definition: A monopolist charges a two part tariff if it charges a per unit fee, r, plus a lump sum fee (paid whether or not a positive number of units is consumed), F

This, effectively, charges demanders of a low quantity a different average price than demanders of a high quantity

Example: hook-up charge plus usage fee for a telephone, club membership, or the

Two Part Tariff

What is the optimal two-part tariff?

Two steps:

(1) maximize the benefits to the consumers

by charging r = MC = 10

(2) capture this benefit by setting F = consumer benefits = 4050

Two Part Tariff

Any higher usage charge would result in a dead-weight loss that could not be captured

by the monopolist Any lower usage charge would result in selling at less than marginal cost

In essence, the monopolist maximizes the size of the "pie", then sets the lump sum fee

so as to capture the entire "pie" for itself.

The total surplus captured is the same as in the case of perfect price discrimination.

Block Tariff

Definition: If a consumer pays one price for one block

of output and another price for another block of output,

the consumer faces a block

Block Tariff

Example

Then:

= p1(Q1)Q1 + p2(Q2)(Q2-Q1) - TC(Q2) = (100 - Q1)Q1 + (100 - Q2)(Q2-Q1) - 10Q2

and we must choose Q1 and Q2 to maximize this profit…

Key Equations

These are two equations in two unknowns that can be solved to obtain:

Block Pricing

Quantity Discrimination

Block Pricing

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.

Third Degree Price Discrimination

discrimination offers a different price for

each segment of the market (or each consumer group) when membership in a segment can be observed

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?

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.)

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

MR1 = 100 - 2Q1 = MC = 20MR2 = 80 - 4Q2 = MC = 20

Q1* = 40Q2* = 15

P1* = 60P2* = 50

80 50

Tie-in Sales – Requirements

Definition: A tie-in sale occurs if customer

can buy one product only if they agree to purchase another product as well

• 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

Tie-in Sales – Bundling

• Package tie-in sales (or bundling)

occur when goods are combined so that customers cannot buy either good separately.

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.

Tie-in Sales – Bundling

Tie-in Sales – Bundling

Optimal Pricing Policy

Without bundling: pc = $1500 pm =

$600

• Profit cm = $800 With bundling: pb = $1800

Tie-in Sales – Bundling

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 Cop

Reservation Price

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