Transcript Economics of Management Strategy BEE3027

Economics of Management Strategy
BEE3027
Lecture 4
Non-linear Pricing
• In this section we will deal with ways how a
monopoly (or a firm with market power) can
capture surplus from consumers.
• These are more sophisticated approaches to
pricing than the standard models of industrial
organisation, which assume firms charge a
single price for each unit sold.
Monopoly problem
• Standard monopolist sets MR = MC to
determine optimal output and price.
• Typical consequence of that is that there are
consumers who would be served in a perfectly
competitive market but are not:
– Deadweight loss.
• How can the problem be overcome?
1st Degree Price discrimination
• In this (rather unrealistic) case, the monopolist
can determine each consumer’s reservation
price and charge that price.
• As a result, the monopolist will extract the
whole consumer surplus.
• It is economically efficient, but it is debatable
whether this is desirable.
3rd Degree Price discrimination
• Here, the monopolist is not able to perfectly
distinguish each consumer’s reservation price.
• However it can screen consumers into types:
– E.g. Students, OAPs.
• As such, it can charge different prices to
different types of consumers.
3rd Degree Price discrimination
• 3rd Degree Price Discrimination can be
beneficial to consumers.
• A key factor is the relative size of the two
groups and their demand elasticities.
• Often, one group will “subsidise” the other.
– Students pay cheaper prices for cinema tickets
2nd Degree Price discrimination
• Another alternative for a monopolist is to give
quantity discounts:
– It can charge different prices for different blocks of
units a consumer purchases.
• This type of pricing scheme is used quite
commonly by utility companies.
– EDF Energy charges a price for the first block of
Kwatts and a lower one for the second block.
2nd Degree Price discrimination
• P = 10 - q
• Monopolist now chooses two blocks of units to sell at
different prices:
– q1 at p1
– (q2 – q1) at p2.
• Profits are given by:   p1q1  p2 (q2  q1 )  cq2
  (10  q1 )q1  (10  q2 )(q2  q1 )  cq2
• Monopolist takes q1as given and maximises profit.
• MR2 = MC =>
q1  c
10  2q2  q1  c  0  q2  5 
2
2nd Degree Price discrimination
• Plug the optimal q2 into the original profit function to
obtain:
q1  c
q1  c
q1  c
  (10  q1 )q1  (10  5 
)(5 
 q1 )  c(5 
)
2
2
2
• Which when simplified gives:
q1  c
q1  c
q1  c
  (10  q1 )q1  (5 
)(5 
)  c(5 
)
2
2
2
2nd Degree Price discrimination
• Calculating the profit maximising condition:
10  2q1  0.5(10  q1 )  c / 2  0
10  c
20  c
q1 
, p1 
3
3
• Plugging the value of q1 back into q2 gives:
10  c
c
q1  c
20  2c
10  2c
3
q2  5 
5

, p2 
2
2
3
3
2nd Degree Price discrimination
• So, if c=0:
q1  10 / 3, p1  20 / 3
q2  20 / 3, p2  10 / 3
• So, the first block of units is more expensive than the
second block of units!
• This allows the monopolist to extract extra consumer
surplus away from the DWL area:
– More efficient!
Two-Part Tariff
• Many services that we purchase charge consumers
with annual membership charges rather than a perunit fee.
–
–
–
–
Gym;
Sports clubs;
Theatres;
Amusement parks.
• The logic is that even a monopolist cannot usually
extract all consumer surplus.
• By adding an extra pricing instrument, the monopolist
is able to extract all CS.
Two-Part Tariff
• The logic behind two-part tariff is that the
monopolist will set P=MC to determine optimal
output and set F = CS to extract full surplus.
• However, there are several problems:
– Monopolist does not necessarily know individual
demand schedules perfectly;
– Consumers will have different demand schedules,
hence if it sets F too high, it may lose some (or all)
customers!
– Still, two-part tariffs are quite common