Monopoly Part 2. Pricing with Market Power Price Discrimination First Degree Price Discrimination Second Degree Price Discrimination Third Degree Price.

Monopoly Part 2Monopoly Part 2

Pricing with Market PowerPricing with Market Power

Price DiscriminationPrice Discrimination

First Degree Price DiscriminationFirst Degree Price Discrimination

Second Degree Price DiscriminationSecond Degree Price Discrimination

Third Degree Price DiscriminationThird Degree Price Discrimination

AR, AC, P

Q

D = AR

MC

MR

Q1

MP1

Q2 Q3

T

N

P3

P2

O

Capturing Consumer SurplusCapturing Consumer Surplus

AR, AC, P

Q

D = AR

MC

MR

Q1

MP1

Q2 Q3

T

N

P3

P2

O

First degree price discriminationFirst degree price discrimination

reservation pricereservation price

AR, AC, P

Q

D = AR

MC

MR

Q1

MP1

Q2

TP2

O

D

E

C

F

BA

ExerciseExercise

Suppose a monopolist has a constant marginal cost MC = 2. The firm faces the demand curve P = 20 – Q. There are no fixed cost.

Suppose a monopolist has a constant marginal cost MC = 2. The firm faces the demand curve P = 20 – Q. There are no fixed cost.

Suppose price discrimination is not allowed. How large will the producer surplus be?

Suppose price discrimination is not allowed. How large will the producer surplus be?

Suppose the firm can engage in perfect first degree price discrimination. How large will be producer surplus be?

Suppose the firm can engage in perfect first degree price discrimination. How large will be producer surplus be?

AR, AC, P

Q

D = AR

Q1

MP2

Q2

TP3

O

N

P1

Q3

Second degree price discriminationSecond degree price discrimination

block pricingblock pricing

AR, AC, P

Q

D = AR

MC

MR

Q0

MP0

Q1 Q3

T

N

P3

P1

O

AC

Q2

P2

R

Third degree price discriminationThird degree price discrimination

A firm must have some market power to price discriminationA firm must have some market power to price discrimination

The firm must have some information about the different amounts people will pay for its product

The firm must have some information about the different amounts people will pay for its product

A firm must be able to prevent resale, or arbitrage A firm must be able to prevent resale, or arbitrage

MR1 = MR2 = MCMR1 = MR2 = MC

Q

P

Q

P

MC

D1MR1

D2MR2

1 1 2 2 Tπ=PQ +P Q -C(Q )1 1 2 2 Tπ=PQ +P Q -C(Q )

1 1 T

1 1 1

PQ C(Q )π= - 0

Q Q Q

1 1 T

1 1 1

PQ C(Q )π= - 0

Q Q Q

T 1 2Q =Q +QT 1 2Q =Q +Q

2 2 T

2 2 2

P Q C(Q )π= - 0

Q Q Q

2 2 T

2 2 2

P Q C(Q )π= - 0

Q Q Q

1MR =MC1MR =MC 2MR =MC

2MR =MC

1 2MR =MR =MC1 2MR =MR =MC

1 2

2

1

1(1 )

P1P (1 )

1 2

2

1

1(1 )

P1P (1 )

ExerciseExercise

Suppose a railroad faces the following demand for coal movement

Pc = 38 – Qc Where Qc is the amount of coal moved when the transport price for coal is Pc.

The railroad’s demand for grain movement is PG = 14 – 0.25QG

where QG is the amount of grain shipped when the transport price for grain is PG.

The marginal cost for moving either commodity is 10.

Suppose a railroad faces the following demand for coal movement

Pc = 38 – Qc Where Qc is the amount of coal moved when the transport price for coal is Pc.

The railroad’s demand for grain movement is PG = 14 – 0.25QG

where QG is the amount of grain shipped when the transport price for grain is PG.

The marginal cost for moving either commodity is 10.What are the profit maximizing rates for coal and grain movement?

What are the profit maximizing rates for coal and grain movement?

Intertemporal Price Discrimination Intertemporal Price Discrimination

Q

P

Dt

Dt+1

MRt+1

MRt

Qt

Pt

Qt+1

Pt+1

Peak – Load PricingPeak – Load Pricing

Q

P

D2

D1

MR1

MR2

Q2

P2

Q1

P1

MC

Peak – Load Pricing & WelfarePeak – Load Pricing & Welfare

Q

P

D2

D1

Q2

P2

Q1

P1

MC

P

Q1*Q2

*

Two Part TariffTwo Part Tariff

Q

P

MCP

Usage Fee Entry Fee

Entry Fee

Two Part TariffTwo Part Tariff

Q

P

MCB

D2D1

A

P

T

Q2 Q1

C

Profit = 2T + ( P – MC )(Q1 + Q2 )Profit = 2T + ( P – MC )(Q1 + Q2 )

Two ConsumersTwo Consumers

BundlingBundling

Three VENUS

10,000

A 12,000 3,000

4,000B

Three VENUS

10,000

A 12,000 4,000

3,000B

Negative correlated

Positive correlated

Separated priceSeparated price

Buy BothBuy only good 2

Buy only good 1Buy neither

P2

P1

R1

R2

Bundled priceBundled price

Buy Both

Buy neither

P2

P1

R1

R2

R2= PB – R1

Bundled priceBundled price

Buy Both

Buy neither

P2

P1

R1

R2

R2= PB – R1

Bundled priceBundled price

Buy Both

Buy neither

P2

P1

R1

R2

R2= PB – R1

AdvertisingAdvertising

π=PQ(P,A)-C(Q)-Aπ=PQ(P,A)-C(Q)-A

Adv

Q(P,A) QMR =P =1+MC

A A

Adv

Q(P,A) QMR =P =1+MC

A A

MRAdv = full Marginal cost of Ad.MRAdv = full Marginal cost of Ad.

Q(P,A)(P-MC) =1

A

Q(P,A)

(P-MC) =1A

A Q(P,A) A(P-MC) =

Q A PQ

A Q(P,A) A(P-MC) =

Q A PQ

A

P

εA=-

PQ εA

P

εA=-

PQ ε

Advertising to sale ratio

Transfer PricingTransfer Pricing

No Outside MarketNo Outside Market

Division 1Division 1 Division 2Division 2

Division XDivision X

Q2 , P2Q1 , P1

Q , P

Firm X

Q = f ( K, L, Q1, Q2 )

x 1 1 2(Q)=R(Q)-C (Q)-C (Q )-C (Q)x 1 1 2(Q)=R(Q)-C (Q)-C (Q )-C (Q)

1 x 1 1NMR =(MR-MC )MP =MC1 x 1 1NMR =(MR-MC )MP =MC

2 x 2 2NMR =(MR-MC )MP =MC2 x 2 2NMR =(MR-MC )MP =MC

For FirmFor Firm

1 1 1 1 1=PQ -C (Q )1 1 1 1 1=PQ -C (Q )

2 2 2 2 2=P Q -C (Q )2 2 2 2 2=P Q -C (Q )

x 1 1 2 2π(Q)=R(Q)-C (Q)-PQ -P Qx 1 1 2 2π(Q)=R(Q)-C (Q)-PQ -P Q

x 1 1 1(MR-MC )MP =MC =Px 1 1 1(MR-MC )MP =MC =P

x 2 2 2(MR-MC )MP =MC =Px 2 2 2(MR-MC )MP =MC =P

Race Car Motors has the following demand for automobile

P = 20,000 – Q

MR = 20,000 – 2QDownstream division cost of assembling cars is

CA( Q ) = 8000Q

MCA = 8000The upstream division cost of producing engines is

CE( QE ) = 2QE2

MCE ( QE ) = 4QE

Race Car Motors has the following demand for automobile

P = 20,000 – Q

MR = 20,000 – 2QDownstream division cost of assembling cars is

CA( Q ) = 8000Q

MCA = 8000The upstream division cost of producing engines is

CE( QE ) = 2QE2

MCE ( QE ) = 4QE

ExerciseExercise

MonopsonyMonopsony

Monopsony is a market consisting of single buyer that can purchase from many sellers.Monopsony is a market consisting of single buyer that can purchase from many sellers.

Some buyers may have Monopsony power : a buyer’s ability to affect the price of a good. Monopsony power enables the buyer to purchase the good for less than the price that would prevail in the competitive market

Some buyers may have Monopsony power : a buyer’s ability to affect the price of a good. Monopsony power enables the buyer to purchase the good for less than the price that would prevail in the competitive market

Competitive Buyer & Competitive SellerCompetitive Buyer & Competitive Seller

AR, P

Q

D = MV

MC

AR, P

Q

ME = AEP*

Q*Q*

AR = MR

Monopsonist BuyerMonopsonist BuyerAR, AC, P

MV

ME

QM

PM

QC

S = AE

PC

AR, AC, P

MV

ME

QM

PM

QC

S = AE

PC

AR, AC, P

ARMR

QM

PM

QC

MC

PC

Monopoly and MonopsonyMonopoly and Monopsony

AR, AC, P

AR, AC, P

MV

ME

Q*

P*

S = AE

MV

ME

Q*

MV – P*

S = AE

P*

MV – P*

Source of Monopsony PowerSource of Monopsony Power

The Elasticity of Market SupplyThe Elasticity of Market Supply

The Number of BuyerThe Number of Buyer

The Interaction among BuyersThe Interaction among Buyers

AR, AC, P

MV

ME

QM

PM

QC

S = AE

PCA

B

C

Deadweight LossDeadweight Loss