Economics 2010 Lecture 13’ Monopoly pricing Monopoly Price discrimination Price discrimination and total revenue Price discrimination and consumer.

Economics 2010Economics 2010

Lecture 13’

Monopoly pricing

MonopolyMonopoly

Price discriminationPrice discrimination and total

revenuePrice discrimination and consumer

surplusPrice and Output DecisionLimits to Price Discrimination

Price DiscriminationPrice Discrimination

Price discrimination is the practice of charging some customers a higher price than others for an identical good or charging an individual customer a higher price on a small purchase than on a large one


Price discrimination is also the practice of charging the same price for goods with different costs (think about your water supply in the valley and on the top of the hills!), but let us keep it simple!


Examples of price discrimination Children and students pay a lower price

than other people to see a movie Magazine subscribers pay a lower price

than buyers at a newsagent’s Vacation travelers pay lower air fares than

business travelers


Perfect price discrimination occurs when a firm charges a different price for each unit sold and charges each customer the maximum price that he/she is willing to pay for each unit


Price differences vs. Price discrimination

Not all price differences are examples of price discrimination

If differences in cost lead to differences in price, there is no price discrimination


An example of a price difference that is not price discrimination ...

Ontario Hydro charges big industrial customers a higher price between 7:00 am and 9:00 am than between midnight and 7:00 am. The reason, peak-time power costs more to generate


Generosity or self-interest?Why would a firm give a discount to

students and seniors if it is trying to maximize profit?

Wouldn’t it make a bigger profit by charging all its customers the “full price”?


It turns out that price discrimination is profitable

To see why, we first look at the connection between price discrimination and total revenue

Price Discrimination and Price Discrimination and Total RevenueTotal Revenue

For a single price monopoly, total revenue equals price multiplied by the quantity sold


For example, Bobbie sells 3 haircuts an hour for $14 each and her total revenue is $42 an hour.

3 x $14 = $42


But suppose Bobbie can sell 2 haircuts an hour for $16 and 1 haircut an hour for $14

16


Her total revenue now increases

16

2 x $16 + $14 = $46

She receives $32 for the first two haircuts plus $14 for the third


Now suppose she can sell 1 haircut an hour for $18, one for $16, and one for $14

16

18


Her total revenue increases again

16

18

$18 + $16 + $14

= $48

It is now $18 + $16 + $14 = $48.


The greater the degree of price discrimination, the greater is the total revenue

Price Discrimination and Price Discrimination and Consumer SurplusConsumer Surplus

Price discrimination captures consumer surplus and converts it into economic profit

This idea is the essence of successful marketing

The greater the degree of price discrimination, the smaller is consumer surplus

Price and Output DecisionPrice and Output DecisionThe single

price case: a base

Bobby maximizes profit by selling 3 haircuts an hour

Price and Output DecisionPrice and Output Decision

The price per haircut is $14 and Bobby’s economic profit is $12 an hour


Now suppose she raises her price to $16 and offers a special for students of only $14

16


She now sells 2 haircuts an hour at $16 and 1 at $14

16


Here ATC of producing 3 haircuts an hour is unchanged at $10 a haircut

But she now gets more revenue

16


Her economic profit increases by $4 an hour to $16 an hour

16

Economic Profit $16.


Now suppose Bobby raises her price to $18 and offers a special for seniors of $16 and for students of $14

16


16

18


She sells 1 haircut an hour for $18, 1 for $16 and 1 for $14


16

18


Again, her ATC of producing 3 haircuts an hour is $10 per haircut


16

18


So her economic profit increases yet further

It now becomes $18 an hour

Economic Profit $16.Economic Profit $18.

16

18


Bobby is now making an economic profit that is 50% higher than with a single price of $14


16

18



She now gets very clever

She notices that her marginal cost of producing a 4th haircut per hour is only $12


16

18


12



16

18


12

This cost is less than her lowest price of $14

She also notices that her ATC of 4 haircuts is still only $10



16

18


12

So she decides to offer yet another special--boys haircuts for $12



16

18


12

She now sells 1 haircut an hour for $18, 1 for $16, 1 for $14, and 1 for $12



16

18


12

Her economic profit now increases by a further $2 an hour Economic

Profit $20.

She is now making an economic profit of $20 an hour

Price and Output DecisionPrice and Output DecisionAn example. Air Canada’s

economy class round trip fares between Toronto and London last summer were: No restrictions $1,645 7 day advance purchase $1,008 14 day advance purchase $958 21 day advance purchase $898

Limits to Price Limits to Price DiscriminationDiscrimination

No resale must be possibleMust be possible to identify groups with

different price-elasticities of demand

NextNext

Comparing Monopoly and Competition

Economics 2010 Lecture 13’ Monopoly pricing Monopoly Price discrimination Price discrimination and total revenue Price discrimination and consumer.

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