Monopoly 2 Flashcards
2 requirements to price discriminate; set different prices for same good
No resale or arbitrage
3rd degree PD:
Discounts based on observable characteristics e.g students vs adults
2nd degree PD
Self selecting mechanisms i.e consumer chooses based on preferences
1st degree PD
Charging consumer price equal to their valuation
(Unrealistic in reality.. asymmetric info)
Look at 3rd degree:
2 groups have different valuations (demand curves) for the same good.
Monopolist can profit max separately for each group.
Which group will face higher prices?
Inelastic group
recall inverse elasticity rule P= C’(q) / 1-1/ε
Assume v₁<v₂. (Group 2 has a higher valuation)
So P1<P2. Where is the non-discriminatory price lie tho? (If price discrimination was banned)
Between P1<Pnd<P2
di: distance between consumer i and factory.
Spatial price discrimination is setting a price dependent on this distance.
Let unit transportation cost be t per unit of distance
Recall P=v+c/2 , what would spatial discrimination price be?
B) whats interesting about this equation
P = v+c+tdi / 2
B) freight absorbtion: full transportation cost is not passed onto consumer (otherwise would be tdi not divided by 2)
Second degree price discrimination: 2 part tariff
We have a fixed free F, and variable price p.
So who does this benefit?
Large buyers benefit in receiving a lower average unit price (since fixed cost spread across more, while small orders face fixed cost price regardless)
What is the optimal pricing strat for one group
B) optimal pricing for 2 groups
Any p above MC causes CS losses
So set p=MC to extract large CS
B) firm weighs extracting one group’s surplus fully , vs larger p for both groups. Depends on groups valuations.
So for 2 groups, when may excluding one group be profitable
If difference in surpluses are high, so then just focus on extracting surplus of one.
2-part tariff: 2 groups of equal size, 1 and 2.
ASSUME V2>V1
Inverse demand functions
D₁ = v₁-p
D₂= v₂ -p
CS = 1/2 (vi -p)² for each group
What is profit for serving both groups
Recall π = (p-c)(v-p)
π = (p-c)D₁ + (p-c)D₂ + 2CS₁
2CS₁: fixed fee
(Need to use CS1 since fixed fee cannot exceed CS of lower value group 1, otherwise they would not participate!) and then x by 2 since2 groups pay the fixed fee
Options for monopolist
Choose p to maximise the profit expression
Or only supply group 2 if it can make a higher total profit by setting P=MC to extract group 2’s full surplus (higher valuation group). Only sell to high valuation group with higher CS, to maximise fixed fee (which is CS)
Forms of 2nd degree PD (3)
Versioning e.g paperback v hardback
Bundling e.g subscriptions for newspapers (package cheaper than buying individually)
Durable-goods pricing strats e.g clearance items
First degree price discrimination: pricing at each consumers valuation.
What is the monopolist essentially doing
Total surplus extracted fully by monopolist
So price discrimination has distributional effects, from consumer to producer
However sometimes PD prevents exclusion of low-valuation consumers, so welfare may not be reduced.
3rd degree PD effect on welfare:
If both groups were already served with a single price, discrimination typically reduces welfare (since gain in profit for producers in discriminating is less than loss in CS from higher prices for one group)
However if single price excluded a group (since valuation too low) discrimination could increase welfare by allowing a lower price for the low value group. (Serving them now)
So decreases welfare if both groups already served, or can increase if discrimination prevents exclusion if the single price was too high and excluded the low valuation group originally.
Second degree PD on welfare (2 part tariff)
At least one group with zero CS (In this case it was group 2, with higher valuation CS extracted)
Variable price is lower than without discrimination, good for large buyers
May prevent exclusion of low valuation group, however doesnt matter since their CS fully extracted
Overall; efficiency gains (smaller DWL) than single monopoly price
So we can say monopoly reduces welfare
How to address (5)
Ban practices that provide monopoly power e.g patents
Subsidise monopolist: since prices increase with MC, subsidies should reduce prices
Encourage entry: reduce firm creation costs
Regulation (RRR, price caps)
Competition policy to prevent expoloitation of mrket power
Regulation: what is typical regulation (2)
B) why are these hard to fulfil in practice
Price caps: max price (con: innovation/quality incentive loss)
Rate of return regulation: e.g a maximum return on their capital (prevents overexcessive profits)
B) since requires info on costs, which can be difficult to get
So monopolists itself arent problem, it is when they abuse monopoly power
Microsoft example:
Accused of exploiting its position to prevent fair competition in other markets
By only letting its products use windows
Why can monopolies be good
Dynamic efficiency, use profits to reinvest
After time, they could charge less than Pm
And if consumers are patient enough, they can wait till prices fall with subs etc. So monopoly pricing is not long term…
