Chapter 10
Monopoly
(Part V)
© 2004 Thomson Learning/South-Western
APPLICATION 10.6: Bundling of
Satellite TV Offerings
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2
Charging $15 per each package would yield $60
from these customers.
A bundling scheme that charges $20 per package, if
purchased individually, or $23 if both are bought,
would yield $86.
Thus, revenue can be increased by the proper
choice of pricing bundles of services.
APPLICATION 10.6: Bundling of
Satellite TV Offerings

Bundling by Direct TV, Inc.
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Bundling prices are shown in Table 1, where the
incremental costs help to demonstrate the bundling
price scheme.
Notice adding sports costs $10 extra, but the full
movie package adds $43 ($15 for Showtime and
$28 for HBO/STARZ).
Both packages together ($51) offers a minor
savings over buying the separate packages.
TABLE 1: Sample Direct TV Program
Options
Package
Total Choice Plus
TCP + 1 option
TCP + 3 options
TCP + 5 options
Total Choice Premium
4
Cost
Incremental
$/Month
Cost
35.99
47.99
66.99
81.99
81.99
-12.00
31.00
46.00
46.00
Marginal Cost Pricing Regulation and
the Natural Monopoly Dilemma
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
By marginal cost pricing the deadweight loss
from monopolies is minimized.
However, this would require a natural
monopoly to operate at a loss.
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5
A unregulated monopoly would produce QA at price
PA in Figure 10.6, yielding a profit of PAABC.
FIGURE 10.6: Price Regulation for a
Natural Monopoly
Price
P
A
A
B
C
AC
MC
MR
6
0
QA
D
QR
Quantity
per week
Marginal Cost Pricing Regulation and
the Natural Monopoly Dilemma
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7
Marginal cost pricing of PR which results in QR
demanded would generate an a loss equal to the
area GFEPR because PR < AC.
Either marginal cost pricing must be
abandoned or the government must subsidize
the monopoly.
FIGURE 10.6: Price Regulation for a
Natural Monopoly
Price
P
A
A
B
C
P
8
F
H
G
E
R
J
0
QA
MR
AC
MC
D
QR
Quantity
per week
Two-Tier Pricing Systems
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9
Under this system the monopoly is permitted to
charge some users a high price and charge
“marginal” users a low price.
The regulatory commission might allow the
monopoly to charge PA and sell QA to one
class of buyers.
Other users would pay PR and would demand
QR - QA.
Two-Tier Pricing Systems


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10
At total output of QR average costs are 0G.
Under this system, monopoly profits (area
PAAHG) balance the losses (area HFEJ).
Here the “marginal user” pays marginal cost
and is subsidized by the “intramarginal” user.
APPLICATION 10.7: Can Anyone
Understand Telephone Pricing?
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11
In January 1, 1984 AT& T formally divested
itself of its seven local Bell Operating
Companies as the result of a 1974 Department
of Justice antitrust suit.
The goal of the restructuring was to improve
the performance and competitiveness of the
U.S. telephone industry.
APPLICATION 10.7: Can Anyone
Understand Telephone Pricing?

Subsidization of Local Phone Service
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Prior to the breakup, regulators forced AT&T to
subsidize local residential phone services.
They covered these losses by charging aboveaverage costs on long distance calls.
Residential services cost an average of $28 per
month but the typical charge was $11.
APPLICATION 10.7: Can Anyone
Understand Telephone Pricing?

After the breakup regulators had to choose
between implementing huge increases in
residential telephone rates or continuing
subsidies.
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13
The politically expedient choice was to force AT&T
and other to continue to subsidize local residential
rates.
APPLICATION 10.7: Can Anyone
Understand Telephone Pricing?

The Telecommunications Act of 1996
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The government used this act to increase entry into
the local phone market to try to reduce the
monopoly power of local providers.
This was attempted by specifying specific conditions
under which these local companies could offer long
distance service.
To obtain this right, local companies had to sell
services to potential entrants into their market.
Rate of Return Regulation
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15
Regulators may permit a monopoly to charge a
price above average cost that will earn a “fair”
rate of return on investment.
If the allowed rate exceeds that an owner might
earn under competitive circumstances, the firm
has an incentive to use relatively more capital
input than needed to minimize costs.