Chapter 11 Pricing with Market Power
Chapter 11 Pricing with Market Power
( Topics to be Discussed
- Capturing Consumer Surplus
- Price Discrimination
- Intertemporal Price Discrimination and Peak-Load Pricing
- The Two-Part Tariff
- Bundling
( Perfect competition
- Pricing without market power (perfect competition) is determined by market supply and demand. : D=MR
( Imperfect competition
- Pricing with market power (imperfect competition) requires the individual producer to know much more about the characteristics of demand as well as manage production. :
- D ( MR
( Capturing Consumer Surplus : Page 370
( Price Discrimination
- Price discrimination is the charging of different prices to different consumers for similar goods.
- First Degree Price Discrimination
o Charge a separate price to each customer: the maximum or reservation price they are willing to pay.
- Second Degree Price Discrimination
o Charge a different price depending on the quantity consumed.
- Third Degree Price Discrimination
o Charge a different price depending on the elasticity.
( Question
Why would a producer have difficulty in achieving first-degree price discrimination?
1) Too many customers (impractical)
2) Could not estimate the reservation price for each customer
( Additional Profit From Perfect First-Degree Price Discrimination : Figure 11.2 on. p372
( First Degree Price Discrimination
- The model does demonstrate the potential profit (incentive) of practicing price discrimination to some degree.
- Examples of imperfect price discrimination where the seller has the ability to segregate the market to some extent and charge different prices for the same product:
- Car salesperson (15% profit margin), Colleges and universities (subsidized loan).
- First-Degree Price Discrimination in Practice : Figure 11.3 on page 374
( Second-Degree Price Discrimination
- Charge a different price depending on the quantity consumed.
- Figure 11.4 on page 375
( Third Degree Price Discrimination
1) Divides the market into two-groups.
2) Each group has its own demand function.
3) Most common type of price discrimination.
4) Third-degree price discrimination is feasible when the seller can separate his/her market into groups who have different price elasticities of demand (e.g. business air travelers versus vacation air travelers, discounts to students and senior citizens.).
( Third Degree Price Discrimination :
- Objectives : on page 377
o MR1 = MR2
o MC1 = MR1 and MC2 = MR2
o MR1 = MR2 = MC
[pic]
[pic]
o Second group of customers: MR2 = MC
o MR1 = MR2 = MC
- Exercise 4 on page 409
( Third Degree Price Discrimination
- Determining relative prices
[pic]
[pic]
- Pricing: Charge higher price to group with a low demand elasticity
- Example: E1 = -2 & E2 = -4
[pic]
- P1 should be 1.5 times as high as P2 : Figure 11.5 on page 378
( Intertemporal Price : Discrimination and Peak-Load Pricing
- Separating the Market With Time
- Initial release of a product, the demand is inelastic (i.e., Book, Movie,Computer)
- Once this market has yielded a maximum profit, firms lower the price to appeal to a general market with a more elastic demand (i.e., Paper back books Dollar Movies)
- Figure 11.7 on page 382
- Demand for some products may peak at particular times.
o Rush hour traffic
o Electricity - late summer afternoons
o Ski resorts on weekends
( Peak-Load Pricing
- Capacity restraints will also increase MC.
- Increased MR and MC would indicate a higher price.
- MR is not equal for each market because one market does not impact the other market.
( The Two-Part Tariff
- The purchase of some products and services can be separated into two decisions, and therefore, two prices.
- Examples
1) Amusement Park: Pay to enter & Pay for rides
2) Tennis Club : Pay to join & Pay to play
3) Rental of Mainframe Computers : Flat Fee & Processing Time
4) Safety Razor : Pay for razor & Pay for blades
( The Two-Part Tariff
- Pricing decision is setting the entry fee (T) and the usage fee (P).
- Choosing the trade-off between free-entry and high use prices or high-entry and zero use prices. : High entrance fee & no fee for ride VS No entrance fee and high fee for ride.
( Two-Part Tariff with a Single Consumer : Figure 11.9 on page 386
( Two-Part Tariff with Two Consumers : Figure 11.10 on page 387
( The Two-Part Tariff With Many Different Consumers : Figure 11.11
- No exact way to determine P* and T*.
- Must consider the trade-off between the entry fee T* and the use fee P*.
- To find optimum combination, choose several combinations of P,T.
( Bundling
- Bundling is packaging two or more products to gain a pricing advantage.
- Conditions necessary for bundling
o Heterogeneous customers
o Price discrimination is not possible
o Demands must be negatively correlated
- An example: Leasing Movie A and Movie B
- Page 393.
( Skip Relative Valuations on page 393.
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