Lesson 2.3 Flashcards
draw producer surplus, consumer surplus and deadweight loss for a monopoly
Equilibrium price is through MR = MC to hit demand curve; CS is below demand and above Price and over to equilibrium quantity; PS is above MC and below price and over to equilibrium quantity; deadweight loss is triangle to left of MC = demand to equilibrium demand
examples of price discrimination
colleges awarding financial aid
what customers value the good higher than the equilibrium price in a monopoly (i.e. reservation price is higher)
segment of demand curve from top to equilibrium price
explain customers on demand curve from equilibrium price to where MC = demand
unwilling to spend equilibrium price for good but reservation price exceeds MC and so they represent profitable sales, but these sales are not made by the monopolist because their equilibrium output stops before
where does profitable output continue until in monopoly?
where Q goes through MC = demand
what happens if monopolist raises equilibrium price?
producer surplus increases
what happens if monopolist lowers equilibrium price?
consumer surplus increases
can a monopolist actually change equilibrium price and why and what is the result of that?
no, it is profit maximizing price. to capture consumer surplus and increase producer surplus they need to do it with more than 1 pricing strategy
when should a manager use multiple pricing strategies?
if benefit of capturing profit exceeds costs of doing so
define: pricing discrimination
When the same (or similar) product is sold at more than one price
when is differences in similar products considered pricing discrimination?
when the differences do not reflect cost differences; when products are sold at prices that are in different ratios to their MC
3 types of pricing discrimination
1st, 2nd, 3rd degree
what is first degree price discrimination also called?
perfect price discrimination
examples of first degree price discrimination
haggling, car dealerships
where is output for a monopolist in first degree
where reservation price / market demand (which becomes MR) = MC
what is market demand?
consumer reservation price
what happens when managers can perfectly discriminate to serve customers from top of demand curve to price equilibrium
producer surplus becomes producer surplus + consumer surplus
what is producer surplus also called?
variable cost profit
what happens when managers can perfectly discriminate to serve customers from price equilibrium to demand curve where demand = MC
increase producer surplus to include the deadweight loss
when are managers price discriminating of 1st degree?
when they capture all consumer surplus and deadweight loss
under 1st degree, what price do managers charge customers?
reservation price
what must managers do to do 1st degree?
small number of buyers and must be able to estimate reservation price
how must 1st degree be operationalized?
by a 2-part tariff
example of second degree price discrimination
utilities
what happens in second degree? and where is producer surplus
charges different prices for different quantities of good; for goods less than x, consumer gets charged where x hits demand curve and producer surplus is that rectangle to the left
where is consumer surplus in second degree?
all areas where producer surplus is not
why is there consumer surplus in second and third degree but not first degree?
discrimination occurs at group level not individual level so consumers retain some surplus
which form of price discrimination is most common?
3rd degree
3 conditions for 3rd degree to hold
1) Demand must be heterogeneous (different demand segments must have significantly different price elasticities of demand)
2) Managers must be able to identify and segregate different segments at moderate cost
3) Markets must be successfully sealed; customers in one segment must not be able to transfer goods to another segment
where do differences in price elasticities arise?
income, taste or availability of substitutes
example of 3rd degree pricing
students have high price elasticity of demand since they have low income; they are price sensitive; often times they get a discount on goods; airlines
what do managers need to do for 3rd degree with respect to Q and P
Managers need to decide how much output to allocate to each class of buyer and at what price so that MR is equal in all classes and classes with lower price elasticity of demand are charged a higher price
what happens in MR class 1 > MR class 2
managers should allocate more output to class 1 until MR 1 = MR 2
ideal output for 3rd degree
MR of each class should be equal and should be equal to MC
profit for 3rd degree
profit = TR class 1 + TR class 2 - TC
why can we separate MR for 3rd degree and not MC?
because revenues in classes are independent of each other whereas MC is not
Total optimal output 3rd degree graph
Let G = horizontal summation of MR curves, then optimal total Q is where MC = G
elasticity/inelasticity/price sensitivity of people who use coupons/rebates and those who don’t
people who use coupons are more elastic, more price sensitive; people who don’t use coupons are more inelastic
what do coupons and rebates lead people to do?
self-select their market segment
why do managers use coupons/rebates to price discriminate?
because customers on less elastic portion of demand curve are willing to pay more (buy good without coupon)
how to determine price and coupon with coupon/rebate price discrimination
1) MR1 = P(1+1/n1) = MC where class 1 is more inelastic (pay without coupon)
2) MR2 = (P-X)(1+1/n2) = MC where class 2 is more elastic (pay with coupon)
3) Price is same for both segments, and X is amount of coupon
when is there 2 different demand curves?
when MR of class segments are different
what is peak load pricing also called?
intertemporal pricing
issues of peak load pricing
Demand for goods is time sensitive or seasonal whereas plant capacity is constant
examples of peak load pricing
roadways, electricity generation, resort and hotel rooms, books released as hard-bound with higher price first; leaders and followers in market
what prices should managers charge in peak load pricing?
high prices in the peak and low in the trough
MC at peak and trough in peak load pricing
MC is usually high in peak because supplier is operating at or near capacity and low in trough
similarities and differences in peak load pricing and 3rd degree discrimination
Both peak load pricing and 3rd degree have separate MR curves for each class but in 3rd degree both classes share same supplier capacity at same time so in 3rd degree MC is a function of Q1 + Q2; in peak load pricing classes share same supplier capacity at different times so, Q1 and Q2 are independent on MC
optimal solution in peak load pricing and graph
MR1 = MC and MR2 = MC; optimal output and price for each class is through where MC = MR for each class and hits demand curve for each class
define 2 part tariffs
when managers set prices so that consumers pay an entry fee and then a use fee for each unit of the product they consume
example of 2 part tariff
golf clubs, phone plans, personal seat license
what is entry fee designed for?
to extract consumer surplus
what is entry fee and use fee like?
entry fee like fixed cost and use fee is like variable cost
what do we assume? (optimal 2 part tariff when all demanders are the same)
each demander has same demand curve, identical preferences; demand curve: P = a - bQ; MC is constant
profit maximization(optimal 2 part tariff when all demanders are the same)
use fee (P*) = MC and entry fee = consumer surplus
profit (optimal 2 part tariff when all demanders are the same)
consumer surplus * demanders - fixed cost
what happens to MC curve when it is constant and horizontal?
MC = AVC
what does optimal 2 part tariff enable managers to do?(optimal 2 part tariff when all demanders are the same) and what is TR the same as
Enables managers to act as 1st degree pricing discriminators. Capture entire consumer surplus through entry fee and convert it into producer surplus. Total Revenue is the same as 1st degree
where do managers produce? (optimal 2 part tariff when all demanders are the same)
where Q is where MC/AVC = demand curve
benefits of 2 part tariff
1) Entry fee is collected at beginning of demand period
2) Managers do not need to know reservation price, they collected the surplus with entry fee
3) Customers reveal preferences
explain 2 part tariffs with rising MC curve
1) MC is upward sloping and linear
2) use fee = MC and entry fee = CS
3) revenue from use fee is square from where P = MC and demand curve and down
4) PS/variable cost profit is positive when MC has positive slope
explain strong demander
willing to purchase more units than weak demander at any given price
2 part tariff - what to do with strong demander and weak demander
1) charge entry fee = CS of strong demander and use fee=MC
2) weak demander is excluded from market because their MC (use fee) is greater than their marginal benefit (CS)
3) VC profit = entry fee
2 part tariff - what to do when strong demander is not much stronger than weak demand
1) set use fee at or above MC at price that maximizes variable cost profit and entry fee = CS of weak demander
2) strong demander will realize some CS
3) variable cost profit will be entry fee *2
in 1st degree, what is the additional revenue managers generate by selling an additional unit of product?
consumer’s reservation price
in 1st degree, what is output and MC same as?
perfectly competitive market
how to find output and price in first degree?
price is P = MC and Q = where Demand (MR) = MC
in 1st degree, what does MC turn into?
AVC
in 1st degree, what does demand curve turn into
MR
optimal profit for 3rd degree
when derivative of profit wrt Q1 and derivative of profit wrt Q2 is 0
what is the elastic portion of the demand curve?
the upper part
what is variable cost of serving customer?
area under MC curve to where it hits Q
variable cost profit with 2 part tariff with rising marginal cost
CS+PS since entry fee = CS
2 part tariff - optimal use fee
1) set use fee = P*
2) find variable cost profit from use fee (P-MC)(Q of both added)
3) find consumer surplus from weak demanders = entry fee wrt P
4) find variable cost profit from entry fee (entry fee * 2)
5) find total variable cost profit
6) then maximize variable cost profit
optimal strategy is one where variable cost profit is optimizes
if monopolist does not price discriminate, what is optimal price and output
1) let P for each = P
2) solve Q = Q1+Q2
3) find TR
4) Find MR
5) let MR = MC
6) find total Q and P
7) input P into individual demand functions to find individual output, don’t divide by 2
what is the formula for the demand curve
P = a-bQ
