1. Lecture 6 Additional topics on monopoly
ECON 4100: Industrial Organization
Lecture 6
Additional topics on monopoly

2. Price discrimination and welfare
Introduction
Price discrimination and welfare
Public Policy towards price discrimination
The multiplant monopoly

3. Price Discrimination and Welfare
Does price discrimination reduce welfare?
First- and second- degree: “not necessarily”
because output is at or near to the efficient level
Third-degree is less clear
monopolist restricts output in each of the individual markets supplied
but markets may be served that would otherwise be left unsupplied
A necessary condition for third-degree price discrimination not to reduce welfare is that it leads to an increase in output

4. Public Policy Uneven Enforcement has been spotty
Robinson-Patman makes price discrimination illegal if it is intended to create a monopoly
One defense is if discriminatory prices are intended to “meet the competition”
Enforcement has been spotty
weak in recent years
but note the pharmaceutical case (textbook page 137)
private actions are possible: see
International restrictions also exist
anti-dumping regulations
these are currently pursued very actively

5. Public Policy Another thing is to consider equity…
Third-degree price discrimination will charge a higher price to those with a lower price-elasticity of demand
That would make the cost of insulin pretty high!!!

6. The Multiplant Monopolist
A monopolist rarely produces all output in one plant
how should production be allocated across plants?
this is especially important if different plants have different costs
To maximize profit set MR = MC on the last unit produced
But with several plants what is MC?
First case:
marginal costs are constant within a plant but varying across plants
each plant has a capacity constraint
Obviously if MC is constant within all plants and the same in all plants, it does not matter how much or little you produce in each!

7. The multiplant monopolist (cont.)
Plant 3 has marginal
cost MC3 and
capacity q3
Price
Suppose that there are
three possible plants.
Arrange them in order
of their marginal costs
Maximize profit by
equating marginal cost
and marginal revenue
Plant 2 has marginal
cost MC2 and
capacity q2
MC3
Plant 1 has marginal
cost MC1 and
capacity q1
Produce output Q* using plant
1 and plant 2. Plant 3 is not
operated (or introduced)
MC2
MC1 MR q1 Q*
q1 + q2
Quantity

8. The multiplant monopolist (cont.)
What happens if marginal costs are not constant?
Output choice
Choose output in such a way that overall or aggregate marginal cost of production is equal to marginal revenue…as usual
How do we know what the Aggregate Cost is?
I think it depends on how you choose to distribute production among plants…choose different shares and aggregate cost will differ for a given level of output
Which proportion should we allocate to each plant then? Equal proportions?
NO!!! Distribute in that particular way that will minimize Aggregate TOTAL Costs: where MC is the same for all plants!
Luckily this is the easiest way for us (one MC several quantities)

9. The multiplant monopolist (cont.)
Then choose your level of output and
Output allocation
operate plants such that marginal cost is equal on the last unit produced in each plant
Why?
If not, then cost can be reduced by reallocating output between plants
For example: suppose MC1 = $10 and MC2 = $15
Reducing output of plant 2 by one unit and increasing output of plant 1 by one unit reduces total costs

10. Suppose MC1 = aq1 and MC2 = bq2
An Example
Suppose MC1 = aq1 and MC2 = bq2
q1 = MC/a ; q2 = MC/b $
 Q =q1 + q2 = MC(a + b)/ab $
Maximize profit
by setting marginal
revenue equal
to marginal cost
 MC = Qab/ (a + b)
MC2 = bq2
Allocate output
to the two plants
to equate
marginal costs
MC1 = aq1
MC1 + MC2 MR
q2*
q1*
Quantity Q*
Quantity

11. Product and Pricing strategies for the multiproduct monopolist
Next:
Product and Pricing strategies for the multiproduct monopolist
Product variety, price discrimination and spatial models
Commodity bundling and tie-in sales
Read Chapters 7 and 8

13. Demand and quality (cont.)
Price
Z2q
P(Q, Z2)
When quality is Z2
price is
Z2q/2
How does increased quality
affect demand?
MR(Z2)
When quality is Z1
price is
Z1q/2
Z1q
P2 = Z2q/2
P1 = Z1q/2
MR(Z1)
P(Q,Z1)
q/2 q
Quantity Q*

14. Demand and quality (cont.)
Price
So an increase is quality from
Z1 to Z2 increases surplus
by this area minus the
increase in quality costs
Social surplus at quality Z2
is this area minus quality
costs
Z2q
The increase is total
surplus is greater than
the increase in profit.
The monopolist produces
too little quality
An increase in quality from
Z1 to Z2 increases
revenue by this area
Z1q
Social surplus at quality Z1
is this area minus quality
costs
P2 = Z2q/2
P1 = Z1q/2
q/2 q
Quantity Q*

15. Demand and quality: an alternative
The increase in
social surplus
is this area
minus the cost of
increased quality
The increase in total
surplus is less than
the increase in profit.
The monopolist produces
too much quality
Price
The increase in
quality increases
profit by this area
minus the cost of
increased quality
Assume that an increase
in quality from Z1 to
Z2 rotates the demand
function as follows
Further assume that
the firm is constrained
to produce output Q
Exporters subject to quotas
tend to export high quality
goods
P(Q,Z2)
This may arise as a result
of an export quota or
other restriction on output
P(Q,Z1) Q
Quantity

16. Demand and quality Derivation of aggregate demand
Order consumers by their reservation prices
Aggregate individual demand horizontally
Price 1 2 3 4 5 6 7 8
Quantity