Chapter 25
Monopoly Behavior
25.1 Price Discrimination
Price discrimination: selling different units of
output at different prices.
 First-degree price discrimination

 Different
units of output for different prices.
 Price schedules differ from person to person.
 Prices differ across quantities as well as consumers.
25.1 Price Discrimination

Second-degree price discrimination
 Different
units of output for different prices.
 Same price for the same quantity.
 Prices differ across quantities, but not across
consumers.

Third-degree price discrimination
 Different
prices for different consumers.
 Same price for the same consumer.
 Prices differ across consumers, but not across
quantities.
25.2 First-degree Price Discrimination
Discrete good
 Reservation
prices
r1=v(1)-v(0)
r2=v(2)-v(1)
r3=v(3)-v(2)
 Gross
Consumer’s
surplus
r1+ r2+ r3=v(3)-v(0)

25.2 First-degree Price Discrimination

Price of the 1st unit: r1



Price of the 2nd unit: r2



ΔCS: zero
ΔPS: r2-MC
Price of the 3rd unit: r3



ΔCS: zero
ΔPS: r1-MC
ΔCS: zero
ΔPS: r3-MC
Can charge v(3) for the
first three units


ΔCS: zero
ΔPS: v(3)-3*MC
25.2 First-degree Price Discrimination

To consumer 1


Sell 8 units
Charge v1(8)

To consumer 2


Sell 3 units
Charge v2(3)
25.2 First-degree Price Discrimination
Each unit of the good is sold at the reservation
price.
 No consumer’s surplus generated.
 The output is Pareto efficient.

25.2 First-degree Price Discrimination

To consumer 1


Sell x10 units
Charge v1(x10)

To consumer 2


Sell x20 units
Charge v2(x20)
25.3 Second-degree Price
Discrimination
Two consumers: high demand and low demand.
 The firm cannot identify the consumers.
 Zero marginal cost assumed for simplicity.
 Screening: price-quantity packages that give
the consumers an incentive to choose the right
package meant for them.

 Two
contracts: (xH, pH), (xL, pL).
 The high demand selects (xH, pH).
 The low demand selects (xL, pL).
25.3 Second-degree Price
Discrimination
Full information
case
 Low demand

 xL=x10, pL=A

High demand
 xH=x20,
pH=A+B+C
25.3 Second-degree Price
Discrimination
Self-selection
 High demand
will choose (xL,
pL) and get B.
 xH=x20, pH=A+C

25.3 Second-degree Price
Discrimination
Adjustment
 Low demand

 xL=x1m, pL=A

High demand
 xH=x20,
pH=A+C+D+E

New profit: E-D
25.3 Second-degree Price
Discrimination
Optimum
 Low demand

 xL=x1m, pL=A

High demand
 xH=x20,
pH=A+C+D
EXAMPLE: Price Discrimination in
Airfares
High demand and low demand: business and
non-business travelers.
 Restricted fare

 Advanced
purchase, inconvenient hours, but cheap.
 Designed for low demand.

Unrestricted fare
 Fully
flexible but expensive.
 Designed for high demand.
25.4 Third-degree Price Discrimination
Two groups of consumers.
 The firm is able to identify the consumers.
 Constant unit price for each market.
 The good cannot be resold.
 Firm’s problem

max p1 ( y1 ) y1  p2 ( y2 ) y2  c( y1  y2 )
y1 , y2
25.4 Third-degree Price Discrimination

F.O.C.:
MR1(y1)=MC(y1+y2)
MR2(y2)=MC(y1+y2)

or

1 
p1 ( y1 ) 1 
  MC ( y1  y2 )
 1 ( y1 ) 

1 
p2 ( y2 ) 1 
  MC ( y1  y2 )
  2 ( y2 ) 
25.4 Third-degree Price Discrimination
|2(y2)| > |1(y1)|: p1>p2
 The market with the higher price must have the
lower elasticity of demand.

25.5 Bundling

Bundles: packages of related goods offered for sale
together.
Willingness to pay for software components
Type of consumer
Word processor
Spreadsheet
Type A consumers
120
100
100
120
Type B consumers
25.5 Bundling

Selling software separately
 Charge
$100 for each software.
 Total revenue: $400.

Bundling
 Charge
$220 for the software suite.
 Total revenue: $440.


Diversity in consumers’ willingness to pay lowers the
price one can charge.
Bundling reduces this diversity.
25.6 Two-Part Tariffs


People go to
Disneyland for rides.
Two prices
 Admission
ticket: t
 Price of rides: p*



Given p*, t=CS
Profits from rides:
(p*-MC)x*
Optimal price:
p*=MC
25.7 Monopolistic Competition

Product differentiation
 Products
are similar, but not identical.
 Coca-Cola and Pepsi-Cola.

Monopolistic competition
 Each
firm faces a downward-sloping demand
curve for its product.
 Free entry into the industry.
 Monopolists with zero profits.
25.7 Monopolistic Competition

Monopolistic
competition
 The
demand curve and
the average cost curve
must be tangent with
each other.