more on monopoly today: why single-price profit maximization is typically inefficient; price...
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More on monopoly
Today: Why single-price profit maximization is typically
inefficient; price discrimination
Today Profit maximization of the monopolist
As usual, set MB = MC to maximize profit
Revenue is the benefit for the monopolist Remember that MB is decreasing for the
monopolist Price discrimination and efficiency
Discounts Perfect price discrimination Rebates and coupons
Single-price profit maximization Remember that
marginal revenue is below the price received by the monopolist (except for the first unit in a discrete case)
See our continuous example we will use today
Single-price profit maximization We will find the
point where MR and MC are equal
Surplus and deadweight loss will then be calculated
MR has same vertical intercept as D, with twice the slope Read Ch. 10
Appendix for algebraic approach to solving monopoly problems
Simple monopoly example For this problem,
note: Linear downward-
sloping demand curve
Linear upward-sloping MC curve
Remember: We maximize profit by setting MR = MC
Simple monopoly example In an efficient
market with many buyers and sellers, point I is the intersection of the supply (MC) and demand curves Price is G,
quantity is H
Simple monopoly example As we will see
with a monopoly, a different, less efficient outcome, occurs
MR = MC at point K
At quantity A, the monopolist can see from point E on the demand curve that price C can be charged
Simple monopoly example Calculating
surplus if this was an efficient market
Recall that triangle JI0 is total surplus in an efficient market
Triangle JIG for consumers
Triangle GI0 for suppliers
Simple monopoly example At price C,
consumer surplus falls to triangle JCE
TR for monopolist is price C times quantity A
Surplus for monopolist is trapezoid CEK0
Simple monopoly example What is lost?
Triangle EIK is lost, since the monopolist stops producing once quantity reaches A
This triangle is deadweight loss (DWL)
Why does DWL occur? Marginal PUBLIC benefit comes from the
demand curve Marginal PRIVATE benefit of the
monopolist comes from the marginal benefit curve
The socially optimal point comes from Marginal PUBLIC benefit The monopolist ignores this when making its
decisions
Price discrimination Price discrimination can take many
forms Discounts of goods and services that have
little or no value if transferred to another person
Perfect price discrimination, where a different price can be charged to each person
Rebates, which require effort to get a discount
Discounts in some businesses with at least some market power
Simple discount examples Discounts at a movie theater
Seniors Students Matinees and “twilight” showings
5% senior discount at a store on Tuesdays
Super $5 Monday (Expos/Padres)
Why are these types of discounts offered?
All of these discounts are applied because demand at a given business depends on the day of the week, the time of day, and/or the average income of a group of people
Why are these types of discounts offered?
Price discrimination helps consumers and business More consumers are able to enter the
market Businesses are able to make more
profits by segmenting markets Business charges price to maximize
profit in each market
Discount example 10 people willing to pay a positive price
to see “Bad Action Movie 4” 5 Non-students
Reservation prices of $10, $9, $8, $7, and $5 5 Students
Reservation prices of $6, $4, $3.25, $2.50, and $1
Assume $1 in VC per moviegoer Sell another ticket if MR ≥ $1
Assumption in the following analysis
Price charged will be equal to the lowest reservation price of all people sold to in a market Any higher price will lower sales Any slightly lower price will decrease
revenue without changing costs
What if there are no discounts?
Type of person Reservation price ($)
Total rev. ($) MR ($)
10
NS 10 10
8
NS 9 18
6
NS 8 24
4
NS 7 28
2
S 6 30
0
NS 5 30
Sell 5th ticket, do not sell 6th ticket; Price is $6
Type of person Reservation price ($)
Total rev. ($) MR ($)
10
NS 10 10
8
NS 9 18
6
NS 8 24
4
NS 7 28
2
S 6 30
0
NS 5 30
Only one student buys a ticket
What if we can segment the market between NS and S?
We can continue to sell to the same non-students while increasing sales to students
We will now look at each market separately
Still sell to 4 NS, but price goes up to $7 to maximize profit
Type of person
Res. price ($) Total rev. ($) MR ($)
10
NS 10 10
8
NS 9 18
6
NS 8 24
4
NS 7 28
–3
NS 5 25
Sell to 3 students, at a price of $3.25 each
Type of person
Res. price ($) Total rev. ($) MR ($)
6
S 6 6
2
S 4 8
1.75
S 3.25 9.75
0.25
S 2.50 10
-5
S 1 5Remember: MC is $1 per moviegoer
Additional profits
Left to student: Calculate profit both with and without price discrimination You should find that profit is higher
with price discrimination
Ultimate price discrimination: Airlines
Airlines probably use price discrimination more than any other business Tickets are non-transferable Discrimination based on date of
purchase Discrimination between First-class,
Business, and Economy seats
Airline price discrimination Prices of various routes out of Santa
Barbara checked on different dates on United Airline’s website
The lowest-cost flight was recorded Some interesting ways to get between Santa
Barbara and another city at lowest cost (Example: Santa Barbara to Los Angeles to Aspen to Denver)
All dates are 2008, for flights departing Santa Barbara 2/8, and returning 2/10
Santa Barbarato Denver
Note that price generally goes up as time progresses
People making late bookings often have higher willingness to pay for flights
Date of
fare
1/23 1/25 1/28 1/30 1/31 2/1 2/3 2/5 2/6 2/7
DEN 351 351 351 351 351 351
746
746
790
790
All fares in dollars
Santa Barbara to…
Price sometimes changes more than once a week
Date of
fare
1/23 1/25 1/28 1/30 1/31 2/1 2/3 2/5 2/6 2/7
JFK 600 600 730 730 360 360
730
730
1370
1370
DEN 351 351 351 351 351 351
746
746
790 790
MSY 592 592 491 495 592 495
796
796
796 796
ORD 402 402 462 314 314 314
612
762
762 762
IAD 573 573 856 330 330 330
959
959
1061
1061
All fares rounded to nearest dollar
What happened 1/30 to 2/1?
Price significantly drops in some flights
Date of
fare
1/23 1/25 1/28 1/30 1/31 2/1 2/3 2/5 2/6 2/7
JFK 600 600 730 730 360 360
730
730
1370
1370
DEN 351 351 351 351 351 351
746
746
790 790
MSY 592 592 491 495 592 495
796
796
796 796
ORD 402 402 462 314 314 314
612
762
762 762
IAD 573 573 856 330 330 330
959
959
1061
1061
All fares rounded to nearest dollar
From United’s website: A sale from 1/29 to 2/1 4 Day U.S. sale Airfare to dozens of U.S. cities--now on
sale through Friday
For a special 4 day period, United is dropping fares to and from many of the country's most visited and exciting destinations. Fly to or from Denver, San Francisco, Los Angeles, Washington-Dulles, and more during the month of February and save with these low rates. Remember though, book on united.com by this Friday, to take advantage!
Another sale held at the same time (also from United’s website)
Chicago 4 day sale Windy city deals are in the air
The Magnificent Mile, Millenium Park, and, of course, the deep dish pizza, are all staples of Chicago. Read more about Chicago. And between now and this Friday, United has put travel to and from Chicago on sale. Just remember to book on united.com, where you'll never pay a booking fee.
One other thing to note These sales usually have many
limitations Notice that one market examined did
not have any discounts during the sale DEN
Other restrictions often apply 4-day US Sale: Stay must be 1-30 days;
travel only allowed through the end of February
Chicago Sale: Complete travel by March 10
If you ignore the sale…
Notice that price generally increases as time progresses
This corresponds to people with a high willingness to pay more often buy their tickets close to the departure date
More price discrimination: Last-minute fares
For flights that are not expected to fill up, some airlines will lower the fare if you are willing to buy no more than a few days before the flight leaves
We will look at fares for SBA to JFK Leaving Saturday 2/9 Returning Monday 2/11
More price discrimination: Last-minute fares (SBA/JFK) From lastminute.com
American Airlines flight, $321 On United’s website, they advertise
weekly e-fares for leaving on Saturday and returning on Monday or Tuesday $326 fare
Similar United flight two weeks later costs $575 Maybe check later to try for a better fare
Why does one day make a difference?
We see that a last-minute fare can be much lower if you leave Saturday and return Monday (relative to Friday and Sunday, respectively)
Why do airlines offer these deals?
Why does one day make a difference? Leisure travelers want to minimize the
amount of work missed They often try to leave Friday for weekend
getaways They want to return on Sunday
Saturday is often a good day to fly from the flexible traveler’s viewpoint Low demand for business travelers Low demand for leisure travelers
Why does one day make a difference?
Airlines know times of low demand They price discriminate in order to
fill up planes, without losing revenue from other customers These offers often have many
limitations United’s e-fares: You must typically
leave Saturday and return two or three days later
More price discrimination
Spirit Airlines often has sale prices below $50 for one-way tickets
However, restrictions are typically extreme Example: You must fly each way on a
Tuesday to get the sale fare
What if you were flexible?
On 1/31, you could have booked a roundtrip from Fort Lauderdale to Nassau, Bahamas for $9 each way if your trip is from 2/12 – 2/26 (both Tuesdays) Even with taxes and fees, the total
round-trip fare is $104.80
What if you were flexible?
Another example on Spirit Airlines, Orlando to Fort Lauderdale (same dates), $19 each way $59 round-trip with taxes and fees Comparable in price to Greyhound’s
7-day advance purchase fare ($58) and Amtrak’s fare ($64)
Perfect price discrimination? Airlines do not perfectly price
discriminate, but they are able to make many more flights profitable by these pricing practices By price discriminating, airlines are able
to offer more flights to more places Perfect price discrimination would
involve being able to charge a price specific to each person
Hurdles: Rebates & coupons
Companies often use another method to price discriminate
Customers are forced to seek a discount if they want to receive it Rebates: Force the customer to send in
a form to receive discount Coupon: Make consumer find a coupon
before purchase to get a discount
Example of hurdle Baseball teams often have lower
attendance in mid-week games against bad teams
A baseball team may coordinate with a sponsor Hypothetical example: “Visit the Duff
Bear display at your local supermarket to get your half-off coupon to select Isotope home games”
Summary of monopoly, part 1 Price can be controlled by the monopolist Various ways can be used to obtain
market power Exclusive control over important inputs;
Patents and copyrights; Government licenses or franchises; Economies of scale; Networks
Downward-sloping MR curve MR slope is twice that of D curve for linear
demand curves
Summary of monopoly, part 2 Unregulated monopolies will set MB =
MC to maximize profit, leading to DWL Monopolies are often controlled to
prevent substantial positive economic profits
Price discrimination and hurdles can reduce inefficiencies of a monopolistic market
Introducing other kinds of markets
We have now studied markets with one seller and many sellers
We have yet to study other markets Product-differentiated markets
Markets with close substitutes (Example: Different brands of frosted-flake cereal)
Markets with a few sellers
Product-differentiated markets An owner of a popular brand of
cereal has some market power over selling its good Firm can copyright the brand of
cereal, a form of market power Demand may be flatly-sloped, due
to the substitutes available Small increase in price may
substantially lower market share