Monopoly and Pricing Strategies
Monopoly and Pricing Strategies
1
Monopoly • A monopoly market has a single seller • Monopoly Pricing • Monopolist chooses the price that maximizes its profit, given the demand for its product • The price and quantity occur at marginal revenue intersect marginal cost ܴܯൌ ܥܯ • monopolist’s marginal revenue less than price ߲ܲ ܴܯൌ ܲ ܳ ܳ ߲ܳ 2
Finding Profit‐Maximizing Sales Quantity for a Monopoly • Step 1: Quantity Rule – Identify positive sales quantities at which – If more than one, find one with highest profit
• Step 2: Shut‐Down Rule – Check whether the quantity from Step 1 yields higher profit than shutting down
3
Monopoly Profit Maximization
4
Welfare Effects of Monopoly Pricing
5
Monopoly Pricing Strategies • Price Discrimination: Pricing to Extract Surplus • A price discriminating monopolist charges different prices for different units of the good
6
Perfect Price Discrimination • Each consumer is charged a different price for each unit given by his willingness to pay • Marginal revenue curve coincides with the market demand curve • Profit‐maximizing sales quantity occurs where the market demand curve crosses the marginal cost curve • Monopolist produces the same quantity as would occur in a competitive industry • No deadweight loss 7
Perfect Price Discrimination Sales Quantity
8
Two‐Part Tariffs • Quantity‐dependent pricing plan to maximize profit • Consumers pay a fixed fee plus a separate per‐ unit price for each unit they buy – Examples: amusement parks, rental car companies
• Advantage is simplicity: name just two prices • To maximize profit, set per‐unit charge equal to marginal cost 9
Two‐Part Tariffs
10
Profit‐Maximizing Price to Two Groups of Consumers
11
Price Discrimination Based on Self‐ Selection • Often firms cannot distinguish between groups of consumers based on observable characteristics • Price discrimination may still be possible • Offer a menu of alternatives
– If properly designed, customers with different willingness to pay will choose different alternatives
• A common practice
– Examples: supermarket discounts for shoppers who clip coupons, wireless phone companies with multiple calling plans 12
Quantity‐Dependent Pricing and Self‐ Selection • A two‐part tariff is not feasible if consumers’ characteristics are not directly observable • If given the choice between two plans with the same per‐minute price, all consumers will opt for the low‐demand (low fixed fee) plan – Consumers will not self‐select based on willingness to pay
• The monopolist can often do better by raising the per‐unit charge above its marginal cost • Can do even better by offering a menu of different two‐part tariffs 13
14
Clearvoice Wireless Example • Wireless telephone monopolist in a rural area • Two types of consumers: high and low demand – Distinct monthly demand for each group
• Clearvoice’s marginal cost is 10 cents • If could observe consumer characteristics, would offer two‐part tariff with 10‐cent per‐ minute price – Fixed fee for low‐demand customers: $8 – Fixed fee for high‐demand customers: $40.50 15
Profit‐Maximizing Two‐Part Tariff • Clearvoice wants to offer a single two‐part tariff • Per‐minute price of $0.10 and monthly fee of $8 – All consumer accept
• Per‐minute price $0.10 and monthly fee $40.50 – High‐demand customers accept – Low‐demand customers reject
• Which plan is better? – With many low‐demand customers, $8 fee is better
• May be even more profitable to raise per‐minute fee above marginal cost 16
Profit‐Maximizing Two‐Part Tariff • For a monopolist selling to both types of consumers it is profitable to raise the per‐unit price at least a little above marginal cost – Regardless of the types’ relative proportions
• Extract some of high‐demand consumers’ surplus without changing surplus of low‐demand consumer (already zero)
– Raise per‐unit price to get more surplus from high‐demand consumers – Adjust fixed fee so low‐demand consumers’ surplus is unchanged
• The smaller the faction of low‐demand consumer, the more worthwhile it is to raise the per‐unit price 17
Benefits of Raising the Per‐Minute Charge
18
Benefits of Raising the Per‐Minute Charge Assume 400 low demand consumers and 100 high demand consumers. Per‐Minute price $0.10 (=MC)
$0.20
Low‐Demand consumer
40
30
High‐Demand consumer
90
80
8
4.5
Low‐Demand consumer
8
7.5
High‐Demand consumer
8
12.50
4000
4250
Minutes purchased
Fixed fee Profits
Total Profit
19
1
Monopoly • A monopoly market has a single seller • Monopoly Pricing • Monopolist chooses the price that maximizes its profit, given the demand for its product • The price and quantity occur at marginal revenue intersect marginal cost ܴܯൌ ܥܯ • monopolist’s marginal revenue less than price ߲ܲ ܴܯൌ ܲ ܳ ܳ ߲ܳ 2
Finding Profit‐Maximizing Sales Quantity for a Monopoly • Step 1: Quantity Rule – Identify positive sales quantities at which – If more than one, find one with highest profit
• Step 2: Shut‐Down Rule – Check whether the quantity from Step 1 yields higher profit than shutting down
3
Monopoly Profit Maximization
4
Welfare Effects of Monopoly Pricing
5
Monopoly Pricing Strategies • Price Discrimination: Pricing to Extract Surplus • A price discriminating monopolist charges different prices for different units of the good
6
Perfect Price Discrimination • Each consumer is charged a different price for each unit given by his willingness to pay • Marginal revenue curve coincides with the market demand curve • Profit‐maximizing sales quantity occurs where the market demand curve crosses the marginal cost curve • Monopolist produces the same quantity as would occur in a competitive industry • No deadweight loss 7
Perfect Price Discrimination Sales Quantity
8
Two‐Part Tariffs • Quantity‐dependent pricing plan to maximize profit • Consumers pay a fixed fee plus a separate per‐ unit price for each unit they buy – Examples: amusement parks, rental car companies
• Advantage is simplicity: name just two prices • To maximize profit, set per‐unit charge equal to marginal cost 9
Two‐Part Tariffs
10
Profit‐Maximizing Price to Two Groups of Consumers
11
Price Discrimination Based on Self‐ Selection • Often firms cannot distinguish between groups of consumers based on observable characteristics • Price discrimination may still be possible • Offer a menu of alternatives
– If properly designed, customers with different willingness to pay will choose different alternatives
• A common practice
– Examples: supermarket discounts for shoppers who clip coupons, wireless phone companies with multiple calling plans 12
Quantity‐Dependent Pricing and Self‐ Selection • A two‐part tariff is not feasible if consumers’ characteristics are not directly observable • If given the choice between two plans with the same per‐minute price, all consumers will opt for the low‐demand (low fixed fee) plan – Consumers will not self‐select based on willingness to pay
• The monopolist can often do better by raising the per‐unit charge above its marginal cost • Can do even better by offering a menu of different two‐part tariffs 13
14
Clearvoice Wireless Example • Wireless telephone monopolist in a rural area • Two types of consumers: high and low demand – Distinct monthly demand for each group
• Clearvoice’s marginal cost is 10 cents • If could observe consumer characteristics, would offer two‐part tariff with 10‐cent per‐ minute price – Fixed fee for low‐demand customers: $8 – Fixed fee for high‐demand customers: $40.50 15
Profit‐Maximizing Two‐Part Tariff • Clearvoice wants to offer a single two‐part tariff • Per‐minute price of $0.10 and monthly fee of $8 – All consumer accept
• Per‐minute price $0.10 and monthly fee $40.50 – High‐demand customers accept – Low‐demand customers reject
• Which plan is better? – With many low‐demand customers, $8 fee is better
• May be even more profitable to raise per‐minute fee above marginal cost 16
Profit‐Maximizing Two‐Part Tariff • For a monopolist selling to both types of consumers it is profitable to raise the per‐unit price at least a little above marginal cost – Regardless of the types’ relative proportions
• Extract some of high‐demand consumers’ surplus without changing surplus of low‐demand consumer (already zero)
– Raise per‐unit price to get more surplus from high‐demand consumers – Adjust fixed fee so low‐demand consumers’ surplus is unchanged
• The smaller the faction of low‐demand consumer, the more worthwhile it is to raise the per‐unit price 17
Benefits of Raising the Per‐Minute Charge
18
Benefits of Raising the Per‐Minute Charge Assume 400 low demand consumers and 100 high demand consumers. Per‐Minute price $0.10 (=MC)
$0.20
Low‐Demand consumer
40
30
High‐Demand consumer
90
80
8
4.5
Low‐Demand consumer
8
7.5
High‐Demand consumer
8
12.50
4000
4250
Minutes purchased
Fixed fee Profits
Total Profit
19
