Monopoly Pricing

1. Monopoly Pricing By Kevin Hinde

2. Aims and Learning Outcomes • explore price discrimination by monopolists and the potential welfare effects. • By the end of this session you will be able to • explain first, second and third degree price discrimination using graphical and numerical examples • explain two part tariffs and block pricing.

3. First Degree Price discrimination P Seller must know each consumers total willingness to pay Effect is for producer to extract total consumer surplus as a profit Pm Note: This is better for society than pure monopoly but it does raise distribution questions Ppc MC = AC D MR 0 Q Qm Qpc

4. Second Degree Price discrimination • Charging different prices based on customer use rates. • Examples • Buy 2 get one half price • First 100 units at a higher price than second 100 units

5. P2 Q2 Second Degree Price discrimination P Note Again: This is better for society than pure monopoly but it does raise distribution questions P1 MC = AC D 0 Q Q1

6. Third Degree Price Discrimination • Charging different prices to different types of consumer. • Examples include: • Geographical price differences • prices aimed at educational and private sector markets. • Variation in prices between domestic and commercial customers. • Note buyers in one market cannot resell in another

7. Some Maths • Assume 2 demands for a big event • Public demand • Qp = 45000 - 200Pp • student Demand • Qs = 100000 - 800Ps • Costs of running event • TC = £1,500,000 + £25Q • Should we charge a uniform price or discriminate?

8. A Uniform Price • Total Demand: Qt = Qp + Qs • Qt = 145,000 - 1000P • P = £145 - £0.001Q • MR = 145 - 0.002Q • MC = 25 • Q = 60,000 • P = £85 • Profit =TR - TC = £2.1 million

9. Public Demand Pp = 225 - 0.005Qp MRp = 225 - 0.01Qp MRp = MC Qp = 20,000 Pp = £125 Student Demand Ps = 125 - 0.00125Qs MRs = 125 - 0.0025Qs MRs = MC Qs = 40,000 Ps = £75 A discriminatory price Profit = TRp + TRs - TC = £2.5 million

10. P1 P P2 MC Q1 Q2 Q = Q1 + Q2 Third Degree Price discrimination Note Once More: This is better for society than pure monopoly but it does raise distribution questions market 1 market 2 Total market Remember that moving from a single monopoly to a discriminating one raises the price in low elasticity markets. These consumers are losing out. So what value should we be putting on their marginal unit of output.

11. Third Degree Price Discrimination Rule • To maximise profits, a firm with market power produces the output at which MR in each market = Group MC. • Note too the relationship between MR in each market and elasticity. MRx= Px (1 + 1) = MC e MRy= Py (1 + 1) = MC e The implication of this is that Firms should charge higher prices in markets where elasticity is low (inelastic) and lower prices in markets with high elasticities

12. Two Part Pricing • A firm can enhance it’s profits by engaging in two part tariffs • Charge a price per unit that equals marginal cost plus a fixed fee equal to the consumer surplus each consumer receives at this per unit price. • Examples • Gyms, Golf Clubs

13. Block Tariffs • By packaging units of a product and selling them as one package, the firm earns more than by single unit pricing. • The profit maximising price on the package is the total value the customer receives for the package, including consumer surplus. • Examples • six packs, toilet rolls etc

14. And Finally... • A summary • Any Questions?