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Chapter 25 Monopoly Behavior

Chapter 25 Monopoly Behavior. 25.1 Price Discrimination. Price discrimination: selling different units of output at different prices. First-degree price discrimination Different units of output for different prices. Price schedules differ from person to person.

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Chapter 25 Monopoly Behavior

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  1. Chapter 25 Monopoly Behavior

  2. 25.1 Price Discrimination • Price discrimination: selling different units of output at different prices. • First-degree price discrimination • Different units of output for different prices. • Price schedules differ from person to person. • Prices differ across quantities as well as consumers.

  3. 25.1 Price Discrimination • Second-degree price discrimination • Different units of output for different prices. • Same price for the same quantity. • Prices differ across quantities, but not across consumers. • Third-degree price discrimination • Different prices for different consumers. • Same price for the same consumer. • Prices differ across consumers, but not across quantities.

  4. 25.2 First-degree Price Discrimination • Discrete good • Reservation prices r1=v(1)-v(0) r2=v(2)-v(1) r3=v(3)-v(2) • Gross Consumer’s surplus r1+ r2+ r3=v(3)-v(0)

  5. 25.2 First-degree Price Discrimination • Price of the 1st unit: r1 • ΔCS: zero • ΔPS: r1-MC • Price of the 2nd unit: r2 • ΔCS: zero • ΔPS: r2-MC • Price of the 3rd unit: r3 • ΔCS: zero • ΔPS: r3-MC • Can charge v(3) for the first three units • ΔCS: zero • ΔPS: v(3)-3*MC

  6. 25.2 First-degree Price Discrimination • To consumer 1 • Sell 8 units • Charge v1(8) • To consumer 2 • Sell 3 units • Charge v2(3)

  7. 25.2 First-degree Price Discrimination • Each unit of the good is sold at the reservation price. • No consumer’s surplus generated. • The output is Pareto efficient.

  8. 25.2 First-degree Price Discrimination • To consumer 1 • Sell x10 units • Charge v1(x10) • To consumer 2 • Sell x20units • Charge v2(x20)

  9. 25.3 Second-degree Price Discrimination • Two consumers: high demand and low demand. • The firm cannot identify the consumers. • Zero marginal cost assumed for simplicity. • Screening: price-quantity packages that give the consumers an incentive to choose the right package meant for them. • Two contracts: (xH, pH), (xL, pL). • The high demand selects (xH, pH). • The low demand selects (xL, pL).

  10. 25.3 Second-degree Price Discrimination • Full information case • Low demand • xL=x10, pL=A • High demand • xH=x20, pH=A+B+C

  11. 25.3 Second-degree Price Discrimination • Self-selection • High demand will choose (xL, pL) and get B. • xH=x20, pH=A+C

  12. 25.3 Second-degree Price Discrimination • Adjustment • Low demand • xL=x1m, pL=A • High demand • xH=x20, pH=A+C+D+E • New profit: E-D

  13. 25.3 Second-degree Price Discrimination • Optimum • Low demand • xL=x1m, pL=A • High demand • xH=x20, pH=A+C+D

  14. EXAMPLE: Price Discrimination in Airfares • High demand and low demand: business and non-business travelers. • Restricted fare • Advanced purchase, inconvenient hours, but cheap. • Designed for low demand. • Unrestricted fare • Fully flexible but expensive. • Designed for high demand.

  15. 25.4 Third-degree Price Discrimination • Two groups of consumers. • The firm is able to identify the consumers. • Constant unit price for each market. • The good cannot be resold. • Firm’s problem

  16. 25.4 Third-degree Price Discrimination • F.O.C.: MR1(y1)=MC(y1+y2) MR2(y2)=MC(y1+y2) • or

  17. 25.4 Third-degree Price Discrimination • |2(y2)| > |1(y1)|: p1>p2 • The market with the higher price must have the lower elasticity of demand.

  18. 25.5 Bundling • Bundles: packages of related goods offered for sale together. Willingness to pay for software components

  19. 25.5 Bundling • Selling software separately • Charge $100 for each software. • Total revenue: $400. • Bundling • Charge $220 for the software suite. • Total revenue: $440. • Diversity in consumers’ willingness to pay lowers the price one can charge. • Bundling reduces this diversity.

  20. 25.6 Two-Part Tariffs • People go to Disneyland for rides. • Two prices • Admission ticket: t • Price of rides: p* • Given p*, t=CS • Profits from rides: (p*-MC)x* • Optimal price: p*=MC

  21. 25.7 Monopolistic Competition • Product differentiation • Products are similar, but not identical. • Coca-Cola and Pepsi-Cola. • Monopolistic competition • Each firm faces a downward-sloping demand curve for its product. • Free entry into the industry. • Monopolists with zero profits.

  22. 25.7 Monopolistic Competition • Monopolistic competition • The demand curve and the average cost curve must be tangent with each other.

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