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
 She
receives
$32 for the first
two haircuts
plus $14 for
the third
16
2 x $16
+ $14 =
$46
Price Discrimination and
Total Revenue
 Now
suppose
she can sell 1
haircut an
hour for $18,
one for $16,
and one for
$14
18
16
Price Discrimination and
Total Revenue
 Her
total
revenue
increases
again
 It is now $18 +
$16 + $14 =
$48.
18
16
$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
18
16
Economic
Profit $16.
Price and Output Decision
 She
sells 1
haircut an
hour for $18, 1
for $16 and 1
for $14
18
16
Economic
Profit $16.
Price and Output Decision
 Again,
her
ATC of
producing 3
haircuts an
hour is $10
per haircut
18
16
Economic
Profit $16.
Price and Output Decision
 So
her
economic
profit
increases yet
further
 It now
becomes $18
an hour
18
16
Economic
Profit $18.
$16.
Price and Output Decision
 Bobby
is now
making an
economic
profit that is
50% higher
than with a
single price of
$14
18
16
Economic
Profit $18.
$16.
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
18
16
12
Economic
Profit $18.
$16.
Price and Output Decision
 This
cost is
less than her
lowest price of
$14
 She also
notices that
her ATC of 4
haircuts is still
only $10
18
16
12
Economic
Profit $18.
$16.
Price and Output Decision
 So
she
decides to
offer yet
another
special--boys
haircuts for
$12
18
16
12
Economic
Profit $18.
$16.
Price and Output Decision
 She
now sells
1 haircut an
hour for $18, 1
for $16, 1 for
$14, and 1 for
$12
18
16
12
Economic
Profit $18.
$16.
Price and Output Decision
 Her
economic
profit now
increases by a
further $2 an
hour
 She is now
making an
economic profit
of $20 an hour
18
16
12
Economic
Profit $20.
$16.
$18.
Price and Output Decision
 An
example. Air Canada’s
economy class round trip fares
between Toronto and London last
summer were:




No restrictions
7 day advance purchase
14 day advance purchase
21 day advance purchase
$1,645
$1,008
$958
$898
Limits to Price
Discrimination
 No
resale must be possible
 Must be possible to identify groups with
different price-elasticities of demand
Next
Comparing
Monopoly and
Competition