Chapter 11: Pricing with Monopoly Power

Price Discrimination

practice of charging different prices to different consumers for similar goods

First-Degree Price Discrimination

practice of charging each customer her reservation price

Reservation Price

maximum price that a customer is willing to pay for a good.

Variable Profit

sum of profits on each incremental unit produced by a firm; i.e., profit ignoring fixed costs.

Perfect Price Discrimination

The additional profit from producing and selling an incremental unit is the difference between demand and marginal cost.

Second-Degree Price Discrimination

practice of charging different prices per unit for different quantities of the same good or service.

Block pricing

practice of charging different prices for different quantities or “blocks
of a good

How cna second-degree price discrimination make consumer better off?

By expanding output and lowering costs

Third-Degree Price Discrimination

Practice of dividing consumers into two or more groups with separate demand curves and charging different prices to each group.

If third-degree price discrimination is feasible, how should the firm
decide what price to charge each group of consumers?

1. We know that however much is produced, total output should
be divided between the groups of customers so that marginal
revenues for each group are equal.
2. We know that total output must be such that the marginal
revenue for each group of consumers is equal to the marginal
cost of production.

Determining Relative Prices

MR = P(1+1/Ed)

P1/P2 = (1+1/E2)/(1+1/E1)

What is the optimal price and quantity when third-degree price discrimination is present?

the marginal revenue from each group is the same and equal to marginal cost.

Intertemporal Price Discrimination

Practice of separating consumers with different demand functions into different
groups by charging different prices at different points in time.

Peak-Load Pricing

Practice of charging higher prices during peak periods when capacity constraints cause marginal costs to be high.

When intertemporal price discrimination takes place, consumers are divided into groups by…

changing the price over time

When intertemporal price discrimination takes place, Initially, the price is ___. The firm captures surplus from ___ who have a high demand for the good and who are unwilling to wait to buy it. Later the price is ___ to appeal to the mass market.

high; consumers; reduced

When peak-load pricing takes place, demands for some goods and services ___ sharply during particular times of the day or year. ___ is higher during peak periods.

increase; marginal cost

Two-Part Tariff

form of pricing in which consumers are charged both an entry and a usage fee.

Bundling

Practice of selling two or more products as a package.

Why is bundling more profitable than selling the films separately?

Because the relative valuations of the two films are reversed

Top Left

Consumers buy only good 2

Top Right

Consumers buy both goods

Bottom left

Consumers buy neither good

Bottom Right

Consumers buy only good 1

Mixed Bundling

mixed bundling Selling two or more goods both as a package and individually

Pure Bundling

Selling products only as a package.

Mixed Bundling with Zero MC

mixed bundling is still more profitable than pure bundling

Tying

Practice of requiring a customer to purchase one good in order to purchase another.

Why might firms use tying?

it often allows a firm to meter demand and thereby practice price discrimination more effectively.

Can be used to extend a firm’s market power and protect customers goodwill connected with a brand name.

Tying