MicroEconomics theory and application 12th by browning an zupan chapter 12

Prepared by Dr. Della Lee Sue, Marist College

MICROECONOMICS: Theory & Applications
Chapter 12: Product Pricing with Monopoly Power
By Edgar K. Browning & Mark A. Zupan
John Wiley & Sons, Inc.
12th Edition, Copyright 2015

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.


Learning Objectives





Explain price discrimination, the various degrees of price
discrimination, and how price discrimination can increase a
firm’s profit.
Spell out the three necessary conditions for a firm to be able
to engage in price discrimination.
Demonstrate how, under third-degree price discrimination,
market segments that have less elastic demand end up being
charged a higher price, all else being equal.
(continued)

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Learning Objectives





(continued)

Show how intertemporal price discrimination, a type of
third-degree price discrimination, can increase a firm’s
profit.
Explore how two-part tariffs, a form of second-degree price
discrimination, can increase a firm’s profit.
Explain the mathematics behind price discrimination.

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

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Explain price discrimination, the various degrees of price discrimination,
and how price discrimination can increase a firm’s profit.

12.1 PRICE DISCRIMINATION

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Price Discrimination




Definition – the practice of charging different prices for the
same product when there is no cost difference to the
producer in supplying the product
Why would a firm want to price discriminate?
 To increase profit
 To increase total surplus (consumer surplus plus
producer surplus)

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Types of Price Discrimination


First-degree (perfect) price discrimination – a policy in
which each unit of output is sold for the maximum price a
consumer will pay



Second-degree price discrimination (block pricing) – the
use of a schedule of prices such that the price per unit

declines with the quantity purchased by a particular
consumer



Third-degree price discrimination (market
segmentation) – a situation in which each consumer faces a
single price and can purchase as much as desired at that
price, but the price differs among categories of consumers
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First-Degree (Perfect) Price
Discrimination


The price schedule is tailored to each consumer: all units are priced at
the maximum price each consumer will pay.



MR curve coincides with the demand curve.



The profit-maximizing output level is efficient.



The monopolist makes the maximum profit given the demand curve



The monopolist captures all of the consumer surplus as profit.



Implementation: monopolist needs to determine what consumer is
willing to pay.
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Figure 12.1 - Price Discrimination Can
Increase Profit

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Second-Degree Price Discrimination
(Block Pricing)


Consumers are charged a different price for different
quantities, with the schedule of prices set to extract the

entire consumer surplus.



Price per unit declines with the quantity purchased by a
particular consumer



The same price schedule confronts all consumers.



Monopolist captures the consumer surplus as profit.

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Figure 12.2 - Second-Degree Price
Discrimination: Block Pricing

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Third-Degree Price Discrimination
(Market Segmentation)




The price differs among categories of consumers.
Examples:
 Faculty discounts at the college bookstore
 Telephone companies charging different monthly rates
for business customers than for residential customers
 Movie theaters charging different prices for a matinee
showing than for an evening showing

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Spell out the three necessary conditions for a firm to be able to engage in
price discrimination.

12.2 THREE NECESSARY CONDITIONS
FOR PRICE DISCRIMINATION

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Three Necessary Conditions for Price
Discrimination
1.

The product seller must possess some degree of monopoly
power; that is, a downward-sloping demand curve.

2.

The seller must have some means of approximating the
maximum amount buyers are willing to pay for each unit
of output.

3.

The seller must be able to prevent resale or arbitrage of the
product among the market segments.

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

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Demonstrate how, under third-degree price discrimination, market
segments that have less elastic demand end up being charged a higher
price, all else being equal.

12.3 PRICE AND OUTPUT
DETERMINATION WITH PRICE
DISCRIMINATION
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Price Determination
Increase total revenue by charging a higher price
to the market segment with the more inelastic
demand

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Figure 12.3 – Gains from Price
Discrimination

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Output Determination
Question: What level of output is most profitable?
 Common value of MR = horizontally sum of the
separate MR curves for each segment
 Guideline: Divide sales between market segments by
comparing the common value of MR with MC

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Figure 12.4 - Price and Output Determination
Under Price Discrimination

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Show how intertemporal price discrimination, a type of third-degree price
discrimination, can increase a firm’s profit.

12.4 INTERTEMPORAL PRICE
DISCRIMINATION AND PEAK-LOAD
PRICING
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Intertemporal Price Discrimination


Definition: a form of third-degree price discrimination in which
different market segments are willing to pay different prices depending
on the time at which they purchase the good



MC is constant.



Profit-maximizing output in each segment is where MR=MC.



Price can be set up to the amount indicated by the demand curve for that
segment.

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Figure 12.5 - Intertemporal Price
Discrimination

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Peak-Load Pricing


Definition: a pricing policy in which different prices are charged for
peak and off-peak periods



MC is not constant.



Price is set where SMC intersects the demand curve.



Advantages:
 A more efficient distribution of usage between the peak and offpeak periods results.
 The required capacity during peak demand is less than that required
under uniform pricing, resulting in a cost saving.

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Figure 12.6 - Peak-Load Pricing

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Explore how two-part tariffs, a form of second-degree price
discrimination, can increase a firm’s profit.

12.5 TWO-PART TARIFFS

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Two-Part Tariffs


Definition: a form of second-degree price discrimination in which a
firm charges consumers a fixed fee per time period for the right to
purchase the product at a uniform per-unit price



Entry fee – the fixed fee charged per time period



Average price falls as larger quantity is purchased.



Conditions:
 Firm must have monopoly power
 Resale of product must be preventable

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