Economics 2010 Lecture 13’ Monopoly pricing

Monopoly  Price discrimination  Price discrimination and total revenue  Price discrimination and consumer surplus  Price and Output Decision  Limits to Price Discrimination

Price 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  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!

Price Discrimination  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

Price Discrimination  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 Discrimination  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

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

Price Discrimination  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”?

Price Discrimination  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 Total Revenue  For a single price monopoly, total revenue equals price multiplied by the quantity sold

Price Discrimination and Total Revenue  For example, Bobbie sells 3 haircuts an hour for $14 each and her total revenue is $42 an hour. 3 x $14 = $42

Price Discrimination and Total Revenue  But suppose Bobbie can sell 2 haircuts an hour for $16 and 1 haircut an hour for $14 16

Price Discrimination and Total Revenue  Her total revenue now increases 16 2 x $16 + $14 = $46  She receives $32 for the first two haircuts plus $14 for the third

Price Discrimination and Total Revenue  Now suppose she can sell 1 haircut an hour for $18, one for $16, and one for $

Price Discrimination and Total Revenue  Her total revenue increases again $18 + $16 + $14 = $48  It is now $18 + $16 + $14 = $48.

Price Discrimination and Total Revenue  The greater the degree of price discrimination, the greater is the total revenue

Price Discrimination and Consumer 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 Decision  The single price case: a base  Bobby maximizes profit by selling 3 haircuts an hour

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

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

Price and Output Decision  She now sells 2 haircuts an hour at $16 and 1 at $14 16

Price and Output Decision  Here ATC of producing 3 haircuts an hour is unchanged at $10 a haircut  But she now gets more revenue 16

Price and Output Decision  Her economic profit increases by $4 an hour to $16 an hour 16 Economic Profit $16.

Price and Output Decision  Now suppose Bobby raises her price to $18 and offers a special for seniors of $16 and for students of $14 16 Economic Profit $

Price and Output Decision  She sells 1 haircut an hour for $18, 1 for $16 and 1 for $14 Economic Profit $

Price and Output Decision  Again, her ATC of producing 3 haircuts an hour is $10 per haircut Economic Profit $

Price and Output Decision  So her economic profit increases yet further  It now becomes $18 an hour Economic Profit $16. Economic Profit $

Price and Output Decision  Bobby is now making an economic profit that is 50% higher than with a single price of $14 Economic Profit $ Economic Profit $18.

Price and Output Decision  She now gets very clever  She notices that her marginal cost of producing a 4th haircut per hour is only $12 Economic Profit $ Economic Profit $18. 12

Price and Output Decision Economic Profit $ Economic Profit $  This cost is less than her lowest price of $14  She also notices that her ATC of 4 haircuts is still only $10

Price and Output Decision Economic Profit $ Economic Profit $  So she decides to offer yet another special--boys haircuts for $12

Price and Output Decision Economic Profit $ Economic Profit $  She now sells 1 haircut an hour for $18, 1 for $16, 1 for $14, and 1 for $12

Price and Output Decision Economic Profit $ Economic Profit $  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 Decision  An 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 Discrimination  No resale must be possible  Must be possible to identify groups with different price-elasticities of demand

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