1. Firms sell consumers products for different prices;
Why?
A firm captures consumers' surplus, enhancing revenue and profits
A firm captures market share
A firm undermines competition or force competition out of market
Example - Standard Oil reduced its price for petroluem products below competitors in one small town
The competitors went out of business
Standard Oil bought the competitors' assets for cents on the dollar and raised prices to earn monopoly profits
Standard Oil entered into another town
Techniques
Market Segmentation – consumers can be separated by markets
Two-part pricing – company charges two fees
Fixed fee: flat fee paid upfront; hookup charge
Variable charge: companies charge per usage; rate charge
T(q) = A + P q
Example: Common for utility companies
Gas
Telephone
Electricity
Tying and bundling – producer sells one product that is required for another product
Quality discrimination – seller sells similar products that differ in quality
2. Conditions for Price Discrimination
Company needs some monopoly power to influence market price
A “mechanism” to separate customers into different groups
Prevent re-sale: Consumer who pays for product for a low price re-sells the product to another consumer who pays a higher price
|
1. First Degree Price Discrimination – monopolist can extract all surplus from customers
Demand function – customers can be ranked by their reservation price
Reservation price – consumer’s willingness to pay
Reservation price (Vi)
Monopolist needs perfect information about customers
Result
Monopolist’s profits = consumers' surplus + producers' surplus
The last customer pays a reservation price, Pi = MC
Discriminating monopolist ensures customers are satisfied in terms of quality, etc.
Monopolist sets P = MC = 10
Consumers' surplus = 0.5 (100 – 10)(90 – 0) = 4,050
Monopolist charges the price T(Q) = 4,050 + 10 Q
Company introduces new product and charges price, P1
After some time, the company lowers the price to P2
After more time, the company lowers the price to P3
Monopolist stops lowering the price, when Pi = MC(Q)
Company will develop a new product to repeat the process
Coase stated
If consumers are sufficiently patient, then consumers could wait for monopoly to drop prices
Have a competitive equilibrium
2. Second Degree Price Discrimination
Monopolist has marginal cost, MC(q1 + q2) = c
Monopolist charges the sensitive consumer
Monopolist charges monopoly prices by MR = MC to the “not sensitive consumers”
Total profits = A + B
3. Third Degree Price Discrimination
Monopolist has information about consumers
Monopolist can separate consumers into groups
Two demand functions, P1(q1) and P2(q2)
Profit maximization, MR1(q1) = MR2(q2) = MC(q1 + q2)
If MC(q1 + q2) = c
Monopolist charges sensitive consumers P1 and not sensitive consumers P2
Not allocative efficient, P2 > P1 > MC
|