Transcript Monopoly Lecture Notes

MONOPOLY and OLIGOPOLY
Economics 310
Chapter 10 and 11
Professor Kenneth Ng
COBAE
California State University, Northridge
Monopoly or Price Searcher
A Monopoly is a firm that is
 the sole seller of its product.
 Produces a product that does not have close
substitutes.
If these two conditions are met then it has some
ability to influence the market price of its product.
This means that when deciding how much to produce
the monopolist cannot take the market price as a
given.
It must consider the interaction between producing
more and getting a lower price or producing less and
getting a higher price.
Why Monopolies Arise
The fundamental cause of monopoly is barriers to entry.
Barriers to entry have three sources:

Ownership of key resource
 Exclusive ownership of an important resource that cannot be readily duplicated is
a potential source of monopoly.

Legal barriers by government
 Patent and copyright laws are a major source of government-created
monopolies.
 Governments also restrict entry by giving a single firm the exclusive right to sell
a particular good in certain markets.
 This is by far the most common source of a monopoly.

Large economies of scale
 An industry is a natural monopoly when a single firm can supply a good or
service to an entire market at a smaller cost than could two or more firms
 Because of economies of scale, the minimum efficient scale of one firm’s plant is
so large that only one firm can supply the market efficiently.
The Simple Monopolists
Output and Price Decision.
A simple monopoly is one that charges a
single unit price and allows all customers to
purchase as much as they want at that price.
There are other types of pricing schemes
which we will consider later.
 Examples.
 Disneyland.
 Movie tickets.
 Price Club.
Monopoly’s, Total, Average,
and Marginal Revenue
Quantity
Q
0
1
2
3
4
5
6
7
8
Price
P
$11
10
9
8
7
6
5
4
3
Total Revenue Average Revenue Marginal Revenue
TR=PxQ
AR=TR/Q
MR=TR/Q
Monopoly’s, Total, Average,
and Marginal Revenue
Quantity
Q
0
1
2
3
4
5
6
7
8
Price
P
$11
10
9
8
7
6
5
4
3
Total Revenue Average Revenue Marginal Revenue
TR=PxQ
AR=TR/Q
MR=TR/Q
$0
10
18
24
28
30
30
28
24
Monopoly’s, Total, Average,
and Marginal Revenue
Quantity
Q
0
1
2
3
4
5
6
7
8
Price
P
$11
10
9
8
7
6
5
4
3
Total Revenue Average Revenue Marginal Revenue
TR=PxQ
AR=TR/Q
MR=TR/Q
$0
10
18
24
28
30
30
28
24
—
$10
9
8
7
6
5
4
3
Monopoly’s, Total, Average,
and Marginal Revenue
Quantity
Q
0
1
2
3
4
5
6
7
8
Price
P
$11
10
9
8
7
6
5
4
3
Total Revenue Average Revenue Marginal Revenue
TR=PxQ
AR=TR/Q
MR=TR/Q
$0
10
18
24
28
30
30
28
24
—
$10
9
8
7
6
5
4
3
—
$10
8
6
4
2
0
–2
–4
Sample Exam Problem
True, false, uncertain. Explain. A monopolist’s
marginal revenue is always less than the price of its
good.
 Hint: When a monopoly drops the price to sell one
more unit, the revenue received from previously
sold units also decreases.
Monopoly’s Marginal Revenue
When a monopoly increases the amount it sells, it
has two effects on total revenue (P x Q).
 The output effect—more output is sold, so Q is
higher.
 The price effect—price falls, so P is lower.
Monopoly’s Demand and
Marginal Revenue Curves
Monopoly’s Demand and
Marginal Revenue Curves
Price
$11
10
9
8
7
6
5
4
3
2
1
0
-1
-2
-3
-4
1
2
3
4
5
6
7
8 Quantity of Water
Monopoly’s Demand and
Marginal Revenue Curves
Price
$11
10
9
8
7
6
5
4
3
2
1
0
-1
-2
-3
-4
Demand
(average revenue)
1
2
3
4
5
6
7
8 Quantity of Water
Monopoly’s Demand and
Marginal Revenue Curves
Price
$11
10
9
8
7
6
5
4
3
2
1
0
-1
-2
-3
-4
Demand
(average revenue)
Marginal
revenue
1
2
3
4
5
6
7
8 Quantity of Water
Price and Output Decision of a
Simple Monopoly
A monopoly maximizes profit by
producing the quantity at which
marginal revenue equals marginal cost.
It then uses the demand curve to find
the price that will induce consumers to
buy that quantity.
Profit Maximization of a
Monopoly
Costs and
Revenue
0
Quantity
Profit Maximization of a
Monopoly
Costs and
Revenue
Demand
Marginal revenue
0
Quantity
Profit Maximization of a
Monopoly
Costs and
Revenue
Marginal
cost
Average total cost
Demand
Marginal revenue
0
Quantity
Profit Maximization of a
Monopoly
Costs and
Revenue
Marginal
cost
Average total cost
A
Demand
Marginal revenue
0
Quantity
Profit Maximization of a
Monopoly
Costs and
Revenue
1. The intersection of the
marginal-revenue curve
and the marginal-cost
curve determines the
profit-maximizing
quantity...
Average total cost
A
Demand
Marginal
cost
Marginal revenue
0
Quantity
Profit Maximization of a
Monopoly
Costs and
Revenue
1. The intersection of the
marginal-revenue curve
and the marginal-cost
curve determines the
profit-maximizing
quantity...
Average total cost
A
Demand
Marginal
cost
Marginal revenue
0
QMAX
Quantity
Profit Maximization of a
Monopoly
Costs and
Revenue
2. ...and then the demand
curve shows the price
consistent with this quantity.
B
Monopoly
price
1. The intersection of the
marginal-revenue curve
and the marginal-cost
curve determines the
profit-maximizing
quantity...
Average total cost
A
Demand
Marginal
cost
Marginal revenue
0
QMAX
Quantity
The Monopolist’s Profit
The Monopolist’s Profit
Costs and
Revenue
0
Quantity
The Monopolist’s Profit
Costs and
Revenue
Demand
Marginal revenue
0
Quantity
The Monopolist’s Profit
Costs and
Revenue
Marginal cost
Average total cost
Demand
Marginal revenue
0
Quantity
The Monopolist’s Profit
Costs and
Revenue
Marginal cost
Monopoly
price
Average total cost
Demand
Marginal revenue
0
QMAX
Quantity
The Monopolist’s Profit
Costs and
Revenue
Marginal cost
Monopoly
price
Average total cost
Average
total cost
Demand
Marginal revenue
0
QMAX
Quantity
The Monopolist’s Profit
Costs and
Revenue
Marginal cost
Monopoly E
price
B
Monopoly
profit
Average
total cost D
Average total cost
C
Demand
Marginal revenue
0
QMAX
Quantity
The Welfare Cost of Monopoly
A monopoly leads to an inefficient allocation of
resources and a failure to maximize total economic wellbeing.
 Another way of stating this is that monopolies are
usually considered bad.
The monopolist produces less than the socially efficient
quantity of output.
 Because a monopoly charges a price above marginal
cost, consumers who value the good at more than its
marginal cost but less than the monopolist’s price
won’t buy it.
Monopoly pricing prevents some mutually beneficial
trades from taking place.
Price
Marginal cost
Value to
buyers
Cost to
monopolist
Demand
(value to buyers)
Cost to
monopolist
Value to buyers
0
Quantity
Value to buyers
is greater than
cost to seller.
Value to buyers
is less than
cost to seller.
Efficient
quantity
The Deadweight Loss
Because a monopoly sets its price above marginal
cost, it places a wedge between the consumer’s
willingness to pay and the producer’s cost.
 This wedge causes the quantity sold to fall short
of the social optimum.
The Deadweight Loss
Price
0
Quantity
The Deadweight Loss
Price
Marginal
revenue
0
Demand
Quantity
The Deadweight Loss
Price
Marginal cost
Marginal
revenue
0
Demand
Quantity
The Deadweight Loss
Price
Marginal cost
Monopoly
price
Marginal
revenue
0
Monopoly
quantity
Demand
Quantity
The Deadweight Loss
Price
Marginal cost
Monopoly
price
Marginal
revenue
0
Monopoly
quantity
Efficient
quantity
Demand
Quantity
The Deadweight Loss
Price
Deadweight
loss
Marginal cost
Monopoly
price
Marginal
revenue
0
Monopoly
quantity
Efficient
quantity
Demand
Quantity
What’s Wrong with Monopoly-Another Look at
the Deadweight Loss.
Another way of thinking about why monopolies are usually considered bad is
to realize that monopolies distort the a market economy’s normally efficient
allocation of productive resources.
 In a market economy, productive resources will only be used to produce
a good if the value of the good to consumers is greater than the cost of
production.
 Firm’s will only produce a good if it can earn a profit by doing so.
Simple monopolists restrict their production to maximize profits.
 The simple monopolist, when they set MC=MR to determine the
profit maximizing output level, produce fewer units of the good than
a competitive firm so they can increase the price.
 At the ouput level where MC=MR, price exceeds marginal cost,
consumers are willing to pay more for extra output than it costs to
produce it.
 From societies point of view, output is too low as some mutually
beneficial transactions are missed.
Let’s look at a graphical illustration of the deadweight loss or distortion of
resource allocation from monopoly.
Allocational and
Distributional Effects of
Monopoly
Price
D
MR
B
P**
P*
A
In the figure, the monopolist is assumed to
produce under conditions of constant
marginal cost.
Further, it is assumed that if the good where
produced by a perfectly competitive
industry, the long-run cost curve would
be the same as the monopolist’s.
In this situation, a perfectly competitive
industry would produce Q* where
demand equals long-run supply.
A monopolist produces at Q** where
marginal revenue equals marginal cost
and charges P**.
The restriction in output (Q* - Q**) is a
measure of the harm done by a
monopoly. E
MC ( =AC)
0
Q**
Q*
Quantity per week
Allocational and
Distributional Effects of
Monopoly
Price
D
P**
P*
MR
The competitive output level (Q* ) is produced
at price P*.
The total value to consumers of Q* units
of the good is the area DEQ*0
Consumers’ pay P*EQ*0.
Consumer surplus, or the amount
consumers would benefit from trade in a
competitive market is DEP*.
A monopolist would produce Q** at price P**.
Total value to the consumer is reduced by
the area BEQ*Q**.
However, the area AEQ*Q** is money
B
freed for consumers to spend elsewhere.
The loss of consumer surplus is BAP*P**.
This is money that was captured by
consumers as a gain from trade but is now
accruing to the Emonopolist
profits.
MCas( =AC)
A
The social loss to monopoly is ABE. This
area represents the unrealized potential
gain from trade that is not captured by
either consumers or monopolist.
0
Q**
Q*
Quantity per week
Allocational and
Distributional Effects
of Monopoly
Price
D
Monopoly profits equal the area P**BAP*.
This would be consumer surplus under
perfect competition.
It does not necessarily represent a loss
of social welfare.
This area represents the redistributional
effects of monopoly that may or may not be
desirable.
The monopolist is richer and the
consumer is poorer.
The redistribution of the social surplus
is why monopolists are considered bad
B
for consumers.
MR
P**
Transfer from
Consumers to firm
P*
E
A
MC ( =AC)
Value of
transferred
inputs
0
Q**
Q*
Quantity per week
Allocational and Distributional
Effects of Monopoly
Price
D
P**
P*
MR
B
Transfer
from
consumers
to firm
Deadweight
loss
A
E
MC ( =AC)
Value of
transferred
inputs
0
Q**
Q*
Quantity per week
A Numerical Illustration of
Deadweight Loss
Consider the following table.
Assume that cassette tapes have a $3 marginal cost and that
this would be the price under perfect competition.
 As shown in the Table, this would result in consumer surplus
equal to $21.
Effects of Monopolization on the Market for Cassette Tapes
If the industry were a monopoly the firm would produce where marginal revenue equals marginal cost,
an output of 4 units.
As shown in the Table, this would result in $12 of monopoly profits and $6 of consumer surplus which
totals $18.
The deadweight loss is the difference between the $21 and the $18 or $3.
Demand Conditions
Quantity
(Tapes
per
Total
Marginal
Price Week)
Revenue Revenue
$9
1
$9
$9
8
2
16
7
7
3
21
5
6
4
24
3
5
5
25
1
4
6
24
-1
3
7
21
-3
2
8
16
-5
1
9
9
-7
0
10
0
-9
Competitive Equilibrium: (P = MC)
Consumer Surplus
Average
and
Marginal
Cost
$3
3
3
3
3
3
3
3
3
3
Totals
Under
Perfect
Competition
$6
5
4
3
2
1
0
---$21
Monopoly equilibrium: (MR = MC)
Under
Monopoly
$3
2
1
0
------$6
Monopoly
Profits
$3
3
3
3
------$12
Price Discrimination
A monopolist using a simple pricing scheme
restricts himself to charging a single price and
letting all customers buy as much of the at
that price as they wish.
Is a monopolist using a simple pricing scheme
maximizing profits?
More sophisticated pricing schemes.
 Price discrimination occurs if identical units
of output are sold at different prices.
Targets for Price Discrimination
The potential theoretical profit for a
monopolist is the sum of all three colored
areas.
Price
D
Using a simple pricing scheme the
monopolist will be able to capture only
the green area.
MR
Consumer
Surplus
B
P**
Profit from a
Simple Pricing
Scheme
P*
Using a simple pricing scheme the
monopolist is missing out on potential
profit equal to the purple and pea green
areas.
Under certain conditions, the monopolist
Deadweight
Loss could capture more of the potential
E
( =AC)
theoretical profit
byMC
price
discriminating.
A
0
Q**
Q*
Quantity
per week
Perfect Price Discrimination
Perfect price discrimination is selling each unit
of output for the highest price obtainable.
 The firm would sell the first unit at slightly
below 0D , the next for slightly less, and so
on until the firm reaches Q*, where a
lower price would result in less profit.
 All consumer surplus (area P*DE) would be
monopoly profit.
 Consider a numeric example.
Effects of Perfect Price Discrimination on the Market for Cassette
Tapes.
Under perfect price discrimination, the monopolist charges each consumer a price equal to their
marginal value.
The perfectly price discriminating monopolist is able to earn to capture all of the potential gain
from trade as profit.
It is impossible for a monopolist to extract any more money from consumers under a system of
voluntary exchange.
Demand Conditions
Quantity
(Tapes
per
Total
Marginal
Price Week)
Revenue Revenue
$9
1
$9
$9
8
2
16
7
7
3
21
5
6
4
24
3
5
5
25
1
4
6
24
-1
3
7
21
-3
2
8
16
-5
1
9
9
-7
0
10
0
-9
Competitive Equilibrium: (P = MC)
Consumer Surplus
Average Under
Perfect
and
Perfect Price
Marginal Compe- Discrimin Consumer
Cost
tition
ation
Surplus
$3
$6
$6
$0
3
5
5
0
3
4
4
0
3
3
3
0
3
2
2
0
3
1
1
0
3
0
0
3
---3
---3
---Totals
$21
$21
$0
Simple Monopoly equilibrium: (MR =
MC)
Perfect Price Discrimination
If the monopolist can perfectly price discriminate, it will produce the same
output as in a competitive market.
 There is no deadweight loss to a perfectly price discriminating
monopolist.
 A perfectly price discriminating monopolist is socially efficient. It will
produce the “right” amount of the good.
If the monopolist can perfectly price discriminate, however, the wealth redistribution effect of monopoly will be maximized.
 The perfectly discriminating monopolist will capture all of the potential
gain from trade.
Why don’t all monopolist’s perfectly price discriminate?
 Two conditions must exist for a monopolist to be able to perfectly
price discriminate.
 This pricing scheme requires a way to determine what each
consumer would be willing to pay.
 The monopolist must be able to stop consumers from selling to
each other.
 It is not normally in the consumer’s best interest to provide this
information.
Example of Prefect Price Discrimination--Financial Aid at Private
Colleges
Prior to the 1990s the U.S. government proposed a formula to
determine a student’s need, and schools would offer such aid.
 Because the formula differed among colleges, the net price
(family contribution) differed.
The Overlap Group (23 prestigious colleges) negotiated the
differences so that each college offered the same net price. The
U.S. Justice Department challenged this pricing scheme as price
fixing.
Although the schools signed a consent decree, they were
exempted from the antitrust laws by the Higher Education Act of
1992. Several innovative pricing schemes were put forth by
schools in the 1990s.
 Several schools adopted sophisticated statistical models used
to offer the lowest price necessary to get a particular
student to accept an offer of admission.
Schools using this approach come very close to perfect price
discrimination
Consider a numeric example.
Price
10
Market Demand
0
9
8
3
5
The chart
shows the
market
demand for a
good.
7
6
8
11
Fill in the
empty cells.
5
4
3
2
1
0
16
21
28
36
45
50
Total Revenue
Marginal
Revenue
Total
Willingness to
Pay
Numeric Example Continued.
Price
10
9
8
7
6
5
4
3
2
1
0
Market
Demand
0
3
5
8
11
16
21
28
36
45
50
Total
Marginal
Revenue Revenue
0
27
9.0
40
6.5
56
5.3
66
3.3
80
2.8
84
0.8
84
0.0
72
-1.5
45
-3.0
0
-9.0
Total
Willingness
to Pay
0
27.0
43.0
64.0
82.0
107.0
127.0
148.0
164.0
173.0
173.0
If MC=0, what price would
the monopolist charge and
what would be the price?
Answer: P= $3, Q=$28.
How much profit would the
monopolist earn?
Answer: P=$84
What is the maximum
theoretical profit the
monopolist could earn?
Answer: $173
What grade would you give
the monopoly’s
management?
Why?
The monopolist is missing
out on $89 of potential
profit.
A Graphical Look
Price
D
MR
.
Depict the outcome of a
monopolist using a simple
pricing scheme.
Show the price and quantity
chosen by the simple
monopolist, consumer
surplus, profits, and the
deadweight loss.
0
Quantity
per week
Q*
A Graphical Look
.
Consumer Surplus:
Price
D
MR
148-84=64
Deadweight Loss:
173-148=25
Consumer
Surplus: $64
$3
Profit: $84
Deadweight
Loss: $25
0
28
Quantity
per week
Q*
Another type of Price
Discrimination--Quantity
Discounts
Quantity discounts reduce the unit
price as consumers buy more of
the good.
Consider a numeric example.
Price
10
9
8
7
6
5
4
3
2
1
0
Consumer X
Quantity
Demanded
0
0
0
1
2
4
6
10
15
21
25
Total Revenue
Marginal
Revenue
Total
Willingness to
Pay
The chart
shows an
individual’s
demand for a
good.
Fill in the
empty cells.
Consider a numeric example.
Price
10
9
8
7
6
5
4
3
2
1
0
Consumer X
Quantity
Demanded
0
0
0
1
2
4
6
10
15
21
25
If MC=0, what price would
the monopolist charge and
what would be the price?
Total
Revenue
0
0
0
7
12
20
24
30
30
21
0
Marginal Total Willingness
Revenue
to Pay
0
0
0
0
0
0
7
7
5
13
4
23
2
31
1.5
43
0
53
-1.5
59
-5.25
59
Answer: P= $2, Q=$15.
How much profit would the
monopolist earn?
Answer: P=$30
What is the maximum
theoretical profit the
monopolist could earn
Answer: $59
What grade would you give
the monopoly’s
management?
Why?
The monopolist is missing
out on $29 of potential
profit.
Consider a numeric example.
Price
10
9
8
7
6
5
4
3
2
1
0
Consumer X
Quantity
Demanded
0
0
0
1
2
4
6
10
15
21
25
Total
Revenue
0
0
0
7
12
20
24
30
30
21
0
Marginal Total Willingness
Revenue
to Pay
0
0
0
0
0
0
7
7
5
13
4
23
2
31
1.5
43
0
53
-1.5
59
-5.25
59
Suppose the monopolist
decided to try to increase
its’ profits using price
discrimination—e.g. a
quantity discount.
What type of pricing
schedule could it offer the
consumer?
$5 for the first 4 units, $2
for additional units.
How much of the good will
the person buy when faced
with the quantity discount?
Consider a numeric example.
$5 for the first 4 units, $2
for additional units.
Price
10
9
8
7
6
5
4
3
2
1
0
Consumer X
Quantity
Demanded
0
0
0
1
2
4
6
10
15
21
25
Total
Revenue
0
0
0
7
12
20
24
30
30
21
0
Marginal Total Willingness
Revenue
to Pay
0
0
0
0
0
0
7
7
5
13
4
23
2
31
1.5
43
0
53
-1.5
59
-5.25
59
How much of the good will
the person buy when faced
with the quantity discount?
The person will buy 4 units
for $5 and 11 additional
units for $2.
The profits of the monopoly
will be $42 (20+$22).
By price discriminating, the
monopolist has increased his
profit by $12.
A Graphical Look
Price
D
MR
0
.
Depict the outcome of a
monopolist using the
quantity discount from the
previous slides.
Quantity
per week
Q*
A Graphical Look
Price
D
.
Compare the social loss and redistribution of
income from consumers to monopolist if the the
monopolist price discriminates with the quantity
discount compared to using a simple pricing
scheme.
MR
The social loss has been has stayed the same.
Consumer
Surplus: $3
The redistribution of the gain from trade from
consumer to monopolist has increased.
$5
Is the particular quantity discount depicted the
most profitable for the monopolist?
Consumer
Surplus: $8
Would the monopolist be better off charging $6
for 2 units, $4 for 4 additional units, and $2 for
additional units?
$2
Profit: $42
Depict this situation on the graph.
Deadweight
Loss: $6
0
4
15
Quantity
per week
Q*
A Graphical Look-Quantity Discount.
Would the monopolist be better off charging $6
.
for 2 units, $4 for 4 additional units, and $2 for
additional units?
Depict this situation on the graph.
D
Price
The total gain from trade for 15 units is $53.
Since the monopolist is getting $46 in
revenue/profit, the consumer surplus is $7.
MR
Consumer
Surplus: $1
The total potential gain from trade is $59.
Therefore there is a $6 deadweight loss.
$6
Consumer
Surplus: $2
$4
Is there a quantity discount that would
eliminate the deadweight loss? Explain.
Consumer
Surplus: $4
$2
Profit: $46
Deadweight
Loss: $6
0
2
6
15
Quantity
per week
Q*
Another Type of Price Discrimination-TwoPart Tariffs
In this pricing scheme, customers must
pay an entry fee for the right to
purchase a good.
Consider a numeric example.
Price
10
9
8
7
6
5
4
3
2
1
0
Consumer X
Quantity
Demanded
0
0
0
1
2
4
6
10
15
21
25
Total
Revenue
0
0
0
7
12
20
24
30
30
21
0
Marginal Total Willingness
Revenue
to Pay
0
0
0
0
0
0
7
7
5
13
4
23
2
31
1.5
43
0
53
-1.5
59
-5.25
59
Suppose the monopolist
used a two-part tariff—
where the person paid a fee
and then consumed as much
of the good as they desired
at a zero price.
Using the same numbers
from the previous example.
Pricing scheme:
Pay $25 and consume as
much of the good as you
wish.
A Graphical Look-Two Part Tariff.
Will the consumer pay the $25 fee or
would he pass on the monopolist’s offer?
Price
D
MR
The consumer would accept because if he
did, he could consume 25 units of the
good at zero cost he would get a gain from
trade of $59.
If he subtracts the $25 fee, he will still
have a net gain from trade of $34.
Is there a deadweight loss?
Consumer
Surplus: $34
$3
Is the monopolist maximizing his profits
under this pricing scheme? How could he
do better?
Entry Fee or
Profit: $25
0
Q
25
A Graphical Look-Two Part Tariff.
Suppose the monopolist increased his fee
to $52. Would this increase his profits?
Price
D
MR
Yes. The monopolist would earn a profit of
$52 and leave the consumer with a $7
consumer surplus.
As the monopolist raises the entry fee,
what happens to the welfare and
distributional effects of monopoly.
Consumer
Surplus: $7
$3
The wealth redistribution from consumers
to firms increases.
Entry Fee or
Profit: $52
0
Q
25
A Graphical Look-Two Part Tariff.
With a $52 entry fee, is the monopolist
maximizing profits?
Is there anyway for the monopolist to
capture the entire $59 gain from trade?
Price
D
MR
What might be the dangers to such a
scheme?
Consumer
Surplus: $9
$3
Entry Fee or
Profit: $50
0
Q
25
APPLICATION: Disneyland Pricing.
During the 1960s Disneyland patrons had to purchase a “passport” containing a
ticket for admission to the rides.

What type of pricing scheme were they using?

Simple pricing scheme.
Disney then switched to a fixed fee for the day and unlimited rides at zero MC.

What type of pricing scheme is this?

Two-Part Tariff or sometimes referred to as an all or nothing offer.
What conditions allow Disneyland to use a more sophisticated pricing scheme?
 Monopoly?
 Resale prevention?
 Know demand or willingness to pay?
 If Disneyland were going to offer a yearly pass, what would they have
to prevent?
Item
Admission
“A” ride
“B” ride
“C” ride
“D” ride
“E” ride
Number of Tickets
Example
in Passport
-1
Shooting Gallery
2
Dumbo, train
3
Peter Pan’s Flight
3
Autopia
2
Space Mountain
5
Price of Extra
Ticket
$4.00
.25
.50
.75
1.00
1.50
A Graphical Look-Disneyland Pricing.
Price
D
MR
$3
Entry Fee or
Profit: $38
0
Q
25
APPLICATION: The Price Club.
Price
D
MR
The Price Club charges a annual
fee but only stocks items in large
sizes.
Price Club claims it only “marks
up” items by a small percentage.
This is an an example of a twopart tariff.
Annual Fee or
Profit: $35
P
MC
0
2 gal.
Market Separation-3rd Degree Price
Discrimination
If the market can be separated into two
or more categories, the monopolist may
be able to charge different prices to
different groups of consumers.
Market Separation
Price
10
9
8
7
6
5
4
3
2
1
0
Consumer X
Quantity
Total
Marginal Total Willingness
Demanded Revenue Revenue
to Pay
0
0
0
0
0
0
0
0
0
0
0
0
1
7
7
7
2
12
5
13
4
20
4
23
6
24
2
31
10
30
1.5
43
15
30
0
53
21
21
-1.5
59
25
0
-5.25
59
Price
10
9
8
7
6
5
4
3
2
1
0
Consumer Y
Quantity
Demanded
0
3
5
7
9
12
15
18
21
24
25
Total Revenue
Total
Marginal Willingness to
Revenue
Pay
Consider two individuals (X and Y) whose demand
schedules for the good are given above.
Fill in the empty columns for consumer y.
Market Separation
Price
10
9
8
7
6
5
4
3
2
1
0
Consumer X
Quantity
Total
Marginal Total Willingness
Demanded Revenue Revenue
to Pay
0
0
0
0
0
0
0
0
0
0
0
0
1
7
7
7
2
12
5
13
4
20
4
23
6
24
2
31
10
30
1.5
43
15
30
0
53
21
21
-1.5
59
25
0
-5.25
59
Price
10
9
8
7
6
5
4
3
2
1
0
Consumer Y
Quantity
Demanded
0
3
5
7
9
12
15
18
21
24
25
Total
Marginal Total Willingness
Revenue Revenue
to Pay
0
0
0
27
9
27
40
6.5
43
49
4.5
57
54
2.5
69
60
2
84
60
0
96
54
-2
105
42
-4
111
24
-6
114
0
-24
114
Suppose the market was composed of these two individuals.
What would the market demand schedule look like?
You would add up the demand of each individual at each
price.
Market Separation
Price
10
9
8
7
6
5
4
3
2
1
0
Consumer X
Quantity
Total
Marginal Total Willingness
Demanded Revenue Revenue
to Pay
0
0
0
0
0
0
0
0
0
0
0
0
1
7
7
7
2
12
5
13
4
20
4
23
6
24
2
31
10
30
1.5
43
15
30
0
53
21
21
-1.5
59
25
0
-5.25
59
Price
10
9
8
7
6
5
4
3
2
1
0
Consumer Y
Quantity
Demanded
0
3
5
7
9
12
15
18
21
24
25
Total
Marginal Total Willingness
Revenue Revenue
to Pay
0
0
0
27
9
27
40
6.5
43
49
4.5
57
54
2.5
69
60
2
84
60
0
96
54
-2
105
42
-4
111
24
-6
114
0
-24
114
Price
10
9
8
7
6
5
4
3
2
1
0
Market
Demand
0
3
5
8
11
16
21
28
36
45
50
Total
Marginal
Revenue Revenue
0
27
9.0
40
6.5
56
5.3
66
3.3
80
2.8
84
0.8
84
0.0
72
-1.5
45
-3.0
0
-9.0
Total
Willingness
to Pay
0
27.0
43.0
64.0
82.0
107.0
127.0
148.0
164.0
173.0
173.0
The market demand curve is the sum of the
demand of each individual in the market.
The total willingness to pay for all consumers
is the sum of the total willingness to pay of
each individual in the market.
What is the maximum profit the monopolist
could earn?
Market Separation
Price
10
9
8
7
6
5
4
3
2
1
0
Price
10
9
8
7
6
5
4
3
2
1
0
Consumer X
Quantity
Total
Marginal Total Willingness
Demanded Revenue Revenue
to Pay
0
0
0
0
0
0
0
0
0
0
0
0
1
7
7
7
2
12
5
13
4
20
4
23
6
24
2
31
10
30
1.5
43
15
30
0
53
21
21
-1.5
59
25
0
-5.25
59
Consumer Y
Quantity
Demanded
0
3
5
7
9
12
15
18
21
24
25
Total
Marginal Total Willingness
Revenue Revenue
to Pay
0
0
0
27
9
27
40
6.5
43
49
4.5
57
54
2.5
69
60
2
84
60
0
96
54
-2
105
42
-4
111
24
-6
114
0
-24
114
Price
10
9
8
7
6
5
4
3
2
1
0
Market
Demand
0
3
5
8
11
16
21
28
36
45
50
Total
Marginal
Revenue Revenue
0
27
9.0
40
6.5
56
5.3
66
3.3
80
2.8
84
0.8
84
0.0
72
-1.5
45
-3.0
0
-9.0
Total
Willingness
to Pay
0
27.0
43.0
64.0
82.0
107.0
127.0
148.0
164.0
173.0
173.0
Suppose the monopolist was restricted to using
a simple pricing scheme, but could charge X
and Y a different price and let them each buy as
much as they wished at that price.
What price would they charge X and Y?
What would happen to the monopolist’s profit
compared to charging them each the same
price?
Compute.
Market Separation
Price
10
9
8
7
6
5
4
3
2
1
0
Price
10
9
8
7
6
5
4
3
2
1
0
Consumer X
Quantity
Total
Marginal Total Willingness
Demanded Revenue Revenue
to Pay
0
0
0
0
0
0
0
0
0
0
0
0
1
7
7
7
2
12
5
13
4
20
4
23
6
24
2
31
10
30
1.5
43
15
30
0
53
21
21
-1.5
59
25
0
-5.25
59
Consumer Y
Quantity
Demanded
0
3
5
7
9
12
15
18
21
24
25
Total
Marginal Total Willingness
Revenue Revenue
to Pay
0
0
0
27
9
27
40
6.5
43
49
4.5
57
54
2.5
69
60
2
84
60
0
96
54
-2
105
42
-4
111
24
-6
114
0
-24
114
Price
10
9
8
7
6
5
4
3
2
1
0
Market
Demand
0
3
5
8
11
16
21
28
36
45
50
Total
Marginal
Revenue Revenue
0
27
9.0
40
6.5
56
5.3
66
3.3
80
2.8
84
0.8
84
0.0
72
-1.5
45
-3.0
0
-9.0
Total
Willingness
to Pay
0
27.0
43.0
64.0
82.0
107.0
127.0
148.0
164.0
173.0
173.0
Simple pricing scheme:
Set MC=MR, produce 28 units and charge $3.
Profits =$84.
Market Separation:
Set MC=MR, charge X-$2 and charge Y-$4 and
produce 30 units. Profits =$90.
Market Separation increased profits by $6.
Market Separation
Price
10
9
8
7
6
5
4
3
2
1
0
Price
10
9
8
7
6
5
4
3
2
1
0
Consumer X
Quantity
Total
Marginal Total Willingness
Demanded Revenue Revenue
to Pay
0
0
0
0
0
0
0
0
0
0
0
0
1
7
7
7
2
12
5
13
4
20
4
23
6
24
2
31
10
30
1.5
43
15
30
0
53
21
21
-1.5
59
25
0
-5.25
59
Consumer Y
Quantity
Demanded
0
3
5
7
9
12
15
18
21
24
25
Total
Marginal Total Willingness
Revenue Revenue
to Pay
0
0
0
27
9
27
40
6.5
43
49
4.5
57
54
2.5
69
60
2
84
60
0
96
54
-2
105
42
-4
111
24
-6
114
0
-24
114
Price
10
9
8
7
6
5
4
3
2
1
0
Market
Demand
0
3
5
8
11
16
21
28
36
45
50
Total
Revenue
0
27
40
56
66
80
84
84
72
45
0
Marginal
Revenue
9.0
6.5
5.3
3.3
2.8
0.8
0.0
-1.5
-3.0
-9.0
Total
Willingness
to Pay
0
27.0
43.0
64.0
82.0
107.0
127.0
148.0
164.0
173.0
173.0
How would you grade the market separation scheme
just analyzed?
Could the monopolist do better?
Yes, there is $83 of unearned potential profit.
How much more could the monopolist get from each
player?
$29 from X and $54 from Y.
Market Separation
Price
10
9
8
7
6
5
4
3
2
1
0
Price
10
9
8
7
6
5
4
3
2
1
0
Consumer X
Quantity
Total
Marginal Total Willingness
Demanded Revenue Revenue
to Pay
0
0
0
0
0
0
0
0
0
0
0
0
1
7
7
7
2
12
5
13
4
20
4
23
6
24
2
31
10
30
1.5
43
15
30
0
53
21
21
-1.5
59
25
0
-5.25
59
Consumer Y
Quantity
Demanded
0
3
5
7
9
12
15
18
21
24
25
Total
Marginal Total Willingness
Revenue Revenue
to Pay
0
0
0
27
9
27
40
6.5
43
49
4.5
57
54
2.5
69
60
2
84
60
0
96
54
-2
105
42
-4
111
24
-6
114
0
-24
114
Price
10
9
8
7
6
5
4
3
2
1
0
Market
Demand
0
3
5
8
11
16
21
28
36
45
50
Total
Revenue
0
27
40
56
66
80
84
84
72
45
0
Marginal
Revenue
9.0
6.5
5.3
3.3
2.8
0.8
0.0
-1.5
-3.0
-9.0
Total
Willingness
to Pay
0
27.0
43.0
64.0
82.0
107.0
127.0
148.0
164.0
173.0
173.0
The basic underlying principle of market separation
strategies is to separate potential buyers into groups
based on their willingness to pay.
Then charge the groups with a high willingness to pay
a high price and the groups with a low willingness to
pay a low price.
Market Separation
Price
10
9
8
7
6
5
4
3
2
1
0
Price
10
9
8
7
6
5
4
3
2
1
0
Consumer X
Quantity
Total
Marginal Total Willingness
Demanded Revenue Revenue
to Pay
0
0
0
0
0
0
0
0
0
0
0
0
1
7
7
7
2
12
5
13
4
20
4
23
6
24
2
31
10
30
1.5
43
15
30
0
53
21
21
-1.5
59
25
0
-5.25
59
Consumer Y
Quantity
Demanded
0
3
5
7
9
12
15
18
21
24
25
Total
Marginal Total Willingness
Revenue Revenue
to Pay
0
0
0
27
9
27
40
6.5
43
49
4.5
57
54
2.5
69
60
2
84
60
0
96
54
-2
105
42
-4
111
24
-6
114
0
-24
114
Price
10
9
8
7
6
5
4
3
2
1
0
Market
Demand
0
3
5
8
11
16
21
28
36
45
50
Total
Revenue
0
27
40
56
66
80
84
84
72
45
0
Marginal
Revenue
9.0
6.5
5.3
3.3
2.8
0.8
0.0
-1.5
-3.0
-9.0
Total
Willingness
to Pay
0
27.0
43.0
64.0
82.0
107.0
127.0
148.0
164.0
173.0
173.0
What are the distributional and welfare effects of
market separation compared to a simple pricing
scheme?
Market Separation increased the monopolist’s profit
from $84 to $90-greater wealth redistribution from
consumer to monopolist.
Because the number of units produced increased,
production more closely approached the amount that
would be produced in a competitive market so the
deadweight loss to monopoly was reduced.
A Graphical Look: Separated Markets Raise the
Possibility of Price Discrimination
Price
P1
P2
D2
MC
D1
MR1
Quantity in market 1 Q*
1
MR
0
Q*
2
2
Quantity in market 2
Market Separation-3rd Degree Price
Discrimination
Why don’t all firms engage in 3rd degree price discrimination or market
separation pricing schemes?
 These schemes are possible only if certain conditions are met.
To engage in a market separation strategy, the monopolist must:
 Have a monopoly.
 Know demand or willingness to pay.
 Must have a way of separating customers into low and
high willingness to pay groups.
 They can then charge the high willingness to pay
customers a high price and the low willingness to pay
customers a low price.
 Because an aware consumer would not be willing to
voluntarily provide this information, the monopolist must
use some other means of obtaining it.
 Personal Characteristics-age, gender, etc.
 Geographic Location.
 Prevent Resale.
Pricing for Multiproduct MonopoliesBundling
If a firm has pricing power in markets for several
related products, other strategies can be used.
 Firms can require users of one product to also buy
a related product such as coffee filters bought
with coffee machines.
Firms can also create pricing bundles such as option
packages on cars or computers.
APPLICATION: Bundling of Satellite TV Offerings
Theory of Program Bundling
Graph shows the willingness to pay of
four consumers for two different packages
of programming, movies and sports.
Two people, A and D, are willing to pay
$20 per month for sports (A) or movies (D)
but nothing for the other type of
programming.
B want sports but some movies and C
wants movies with some sports.
Movies
20 D
C
15
8
B
A
8
15
20
Sports
APPLICATION: Bundling of Satellite TV Offerings
If the monopolist charged $15 for
each package, how much revenue
would it generate?
Charging $15 per each package
would yield $60 from these
customers.
D and C would buy movies.
A and B would buy sports.
A bundling scheme that charges $20
per package, if purchased individually,
or $23 if both are bought, would yield
$86.
Thus, revenue can be increased by
the proper choice of pricing bundles
of services.

Movies
20 D
C
15
8
B
A
8
15
20
Sports
APPLICATION: Bundling of Satellite TV
Offerings
Bundling by Direct TV, Inc.
 Bundling prices are shown in the table, where the incremental costs
help to demonstrate the bundling price scheme.
 Notice adding sports costs $10 extra, but the full movie package
adds $43 ($15 for Showtime and $28 for HBO/STARZ).
 Both packages together ($51) offers a minor savings over buying
the separate packages.
Package
Basic 95 Channel Package
Gold: Basic + Sports
Basic + Showtime
Basic + HBO/STARZ
Basic + HBO/STARZ + Showtime
Platinum: Basic + Sports + Movie
Cost
$/Month
29.99
39.99
44.99
57.99
72.99
80.99
Incremental
Cost
-10.00
15.00
28.00
43.00
51.00
The Real World: Mix and Match Pricing
Strategies.
We have discussed several different types of pricing schemes,
1. Simple pricing.
2. Perfect Price Discrimination.
3. Quantity Discounts.
4. All or Nothing Offers.
5. Multi-Part Tariffs.
6. 3rd Degree Price Discrimination-Market Separation.
In the real world, monopolists mix and match, combining pricing
schemes.
Combination Schemes
Price
10
9
8
7
6
5
4
3
2
1
0
Price
10
9
8
7
6
5
4
3
2
1
0
Consumer X
Quantity
Total
Marginal Total Willingness
Demanded Revenue Revenue
to Pay
0
0
0
0
0
0
0
0
0
0
0
0
1
7
7
7
2
12
5
13
4
20
4
23
6
24
2
31
10
30
1.5
43
15
30
0
53
21
21
-1.5
59
25
0
-5.25
59
Consumer Y
Quantity
Demanded
0
3
5
7
9
12
15
18
21
24
25
Price
10
9
8
7
6
5
4
3
2
1
0
Market
Demand
0
3
5
8
11
16
21
28
36
45
50
Total
Revenue
0
27
40
56
66
80
84
84
72
45
0
Marginal
Revenue
9.0
6.5
5.3
3.3
2.8
0.8
0.0
-1.5
-3.0
-9.0
Total
Willingness
to Pay
0
27.0
43.0
64.0
82.0
107.0
127.0
148.0
164.0
173.0
173.0
A simple pricing scheme yields-$84.
Total
Marginal Total Willingness
Revenue Revenue
to Pay
0
0
0
27
9
27
40
6.5
43
49
4.5
57
54
2.5
69
60
2
84
60
0
96
54
-2
105
42
-4
111
24
-6
114
0
-24
114
3rd degree price discrimination plus simple pricing
yields $90.
How could the monopolist get more by combining
different schemes?
3rd degree price discrimination plus two-part tariff.
3rd degree price discrimination plus all-or-nothing
offer.
Etc.
Wealth Redistribution, Deadweight Loss and
Monopoly- A Summary
Compared to a competitive market, a monopolist using simple pricing produces two few
units of the good.
By restricting output and raising price, he causes a wealth redistribution from consumer
to monopolist, but also produces too few units of the good creating a deadweight loss.
(a) Monopolist with Single Price
Monopoly
Price
(b) Monopolist with Perfect Price Discrimination
Price
Consumer
surplus
Deadweight
loss
price
Profit
Profit
Marginal
revenue
0
Quantity sold
Marginal cost
Marginal cost
Demand
Demand
Quantity
0
Quantity sold
Quantity
Wealth Redistribution, Deadweight Loss and
Monopoly- A Summary
Monopolists who are able to successfully use more sophisticated pricing schemes,
increase the wealth redistribution from monopoly while simultaneously expanding output
and reducing the deadweight loss.
True, false, uncertain. Explain. Allowing monopolists to use more sophisticated pricing
schemes is good for society?
(a) Monopolist with Single Price
Monopoly
Price
(b) Monopolist with Perfect Price Discrimination
Price
Consumer
surplus
Deadweight
loss
price
Profit
Profit
Marginal
revenue
0
Quantity sold
Marginal cost
Marginal cost
Demand
Demand
Quantity
0
Quantity sold
Quantity
MONOPOLY
End of Chapter 10
Cost
Average
total
cost
0
Figure 15-1
Quantity of Output
(a) A Competitive Firm’s Demand Curve
Price
(b) A Monopolist’s Demand Curve’
Price
Demand
Demand
0
Figure 15-2
Quantity of Output
0
Quantity of Output
Price
$11
10
9
8
7
6
5
4
3
2
1
0
-1
-2
-3
-4
Figure 15-3
Demand
(average revenue)
Marginal
revenue
1
2
3
4
5
6
7
8 Quantity of Water
Costs and
Revenue
2. ...and then the demand
curve shows the price
consistent with this quantity.
B
Monopoly
price
1. The intersection of the
marginal-revenue curve
and the marginal-cost
curve determines the
profit-maximizing
quantity...
Average total cost
A
Demand
Marginal
cost
Marginal revenue
0
Figure 15-4
Q1
QMAX
Q2
Quantity
Costs and
Revenue
Marginal cost
Monopoly E
price
B
Monopoly
profit
Average
total cost D
Average total cost
C
Demand
Marginal revenue
0
Figure 15-5
QMAX
Quantity
Costs and
Revenue
Price
during
patent life
Price after
patent
expires
Marginal
cost
Marginal
revenue
0
Figure 15-6
Monopoly
quantity
Competitive
quantity
Demand
Quantity
Price
Marginal cost
Value to
buyers
Cost to
monopolist
Demand
(value to buyers)
Cost to
monopolist
Value to buyers
0
Quantity
Value to buyers
is greater than
cost to seller.
Value to buyers
is less than
cost to seller.
Efficient
quantity
Figure 15-7
Price
Deadweight
loss
Marginal cost
Monopoly
price
Marginal
revenue
0
Figure 15-8
Monopoly Efficient
quantity quantity
Demand
Quantity
Price
Average
total cost
Average total cost
Loss
Regulated
price
Marginal cost
Demand
0
Figure 15-9
Quantity
(a) Monopolist with Single Price
Price
(b) Monopolist with Perfect Price Discrimination
Price
Consumer
surplus
Deadweight
loss
Monopoly
price
Profit
Profit
Marginal
revenue
0
Figure 15-10
Quantity sold
Marginal cost
Marginal cost
Demand
Demand
Quantity
0
Quantity sold
Quantity