Econ 300 final

First-degree price discrimination

First-degree price discrimination is also called "perfect price discrimination" because it assumes that the producer can charge each consumer his exact willingness to pay (or "reservation price").

What is the pricing rule for third degree P.D.?

MR1 = MR2 =MC Find mr1 and match with d1 to find price and q Find mr2 and find d2 to find price and q Mr is set where MRf = mc Price declines as quantity goes up

Since the game is simultaneous, how can firms coordinate their actions so they both benefit?

One firm may signal its intentions to the other firm through a press release.

strategy

Rule or plan of action for playing a game.

Second-degree price discrimination definition 2

Second-degree price discrimination occurs when the firm cannot tell consumers apart (elasticity-wise) when they enter a store; thus, the firm designs a pricing scheme where different consumers will self-select into the product/bundle that is designed for them. For example, suppose a liquor company produces a high-quality vodka that they advertise as one of the smoothest and best-tasting available. They call it "Three Star Golden Crown" and sell it for $16 per bottle. However, the company also takes some of this same vodka and bottles it under the name, "Old Sloshbucket" and sells it for $8 per bottle. selling same product with different names

Monopolistic competition

A market characterized by monopolistic competition is similar to a perfectly competitive market, but products are differentiated. i. Examples: toothpaste, packaged coffee Firms have a little market power, but not much. The extent of a firm's market power depends on how well it can differentiate its product from other similar products in the market.

What is the Cournot Duopoly model?

A model of oligopoly firm behavior in which a homogeneous product is produced and each firm chooses quantity while taking its competitors' actions into account. Simultaneous game (i.e. all firms make their quantity decisions at the same time) ii. Market price depends on total market output

oligopoly market

An oligopoly market has a "few" firms. Entry barriers exist (e.g. licensing requirements, scale economies, or the large fixed costs associated with name recognition) and products may or may not be differentiated. There is a small enough number of firms that each firm takes into account the others' actions/reactions when choosing its own actions; firms act strategically. Oligopoly firms can see how their choices affect market price. In addition, they must also try to anticipate how their rivals' choices will affect market price.

Negatively correlated demands are very important for bundling; why?

Theater A is willing to pay more than Theater B for the hit; Theater B is willing to pay more than Theater A for the flop).

reservation price

consumer his exact willingness to pay

What is bundling

is the practice of selling two or more products as a package. It should be used when consumers have different demands but the firm cannot charge different prices.

There is no simple formula to find the optimal entry and usage fees when there are

many consumers;

The Nash equilibrium for the Bertrand model

p =mc

Assume competitors in a game are

rational

Mixed strategies

a players makes a random choice based on probabilities.

For a single consumer for a two part tariff

a simple solution allows the firm to capture all consumer surplus. The firm sets the usage fee, P, equal to marginal cost and the entry fee, T, equal to the total consumer surplus. marginal cost = price

For a single consumer,

a simple solution allows the firm to capture all consumer surplus. The firm sets the usage fee, P, equal to marginal cost and the entry fee, T, equal to the total consumer surplus. The figure below illustrates this.

sequential games vs simultaneous games

are more complex than simultaneous games (thus far, we have only dealt with simultaneous games). In sequential games, timing matters. Sometimes, the first player to make a decision has an advantage (called a "first-mover advantage"). Additionally, a firm may invest in a credible threat (e.g. building extra capacity to demonstrate its ability to flood the market with output at any time). This can considerably change the outcome of the game.

the goal of second- and third-degree price discrimination

charge a higher price to consumers with inelastic demand, and charge a lower price to consumers with elastic demand. This is will increase overall revenue. In order to accomplish this, however, the firm needs to separate consumers in some way; ideally, the separation will correlate highly with demand elasticity.

In infinite games (

cooperation is easier to achieve because the long-run gain of cooperation outweighs the short-run defection profit. However, the temptation to defect may be stronger for some players than others. Mathematically, economists use a variable ("discount factor") to describe firms' patience; more patient firms are less likely to defect.

In a finitely repeated game

cooperation is, in theory, impossible to achieve.

Define intertemporal P.D. intertemporal price discrimination

describes the practice of separating consumers with different demand functions into different groups by charging different prices at different points in time. For example, a publisher might charge a high price for the hardcover edition of a book and then release a paperback version at a much lower price about a year later. Many people think that the lower price of the paperback is due to a lower cost of production, but it is actually usually due to price discrimination. different prices at different times

Block pricing for a natural monopoly

economies of scale cause average and marginal costs to continue declining over the entire relevant range of demand the prices for the second and third blocks are less than the monopoly price, but the firm still earns profit because costs decrease as output increases. Consumer welfare may also increase.

In what industry is block pricing typically used?

electric industry

The price to sell at and quantity to sell is where

find where mr =mc and than do up to the demand curve

What kind of firms can practice first degree price discrimination

firms who know each client reasonably well (e.g. corporate lawyers or architects) may be able to come close to perfect price discrimination because they may be able to estimate each client's willingness to pay. A good car salesperson who can size up his customers fairly well can negotiate a different price with each customer.

dominant strategies equilibrium vs Nash equilibrium

im doing the best I can no matter what you do. You're doing the best you can no matter what I do. Nash Equilibrium: I'm doing the best I can given what you are doing. You're doing the best you can given what I am doing.

if demand for a good or service remains unchanged even when the price changes, demand is said

inelastic

collusive optimum

is highest payoff if both firms work together

The Nash Equilibrium of this game is for both prisoners

is to confess Although they would both be better off if neither confessed, they each have a private incentive to confess. One way to look at this is: Prisoner A is better off choosing the "CONFESS" strategy regardless of what Prisoner B does. This is true for Prisoner B as well. A Nash Equilibrium constitutes a set of strategies where neither player is better off changing his behavior; thus, we say that the Nash is "Confess, Confess" (not "-5, -5").

Residual demand

left over demand

Oligopoly firms have quite a bit of

market power . Firms may compete ferociously (e.g. Bertrand pricing model or building extra capacity to have a "credible threat" to deter entry) Firms may act cooperatively (e.g. tacit collusion ("unspoken agreement") or cartels (illegal in the U.S.))

What products/services are frequently bundled?

movies Cable companies often bundle their channels because they know that demands for the different channels are negatively correlated. This is because there are only 24 hours in a day and consumers can only watch one channel at a time; a consumer who spends most of his time watching channel A cannot possibly spend most of his time watching channel B.

Nash Equilibrium occurs when

no firm is better off changing its strategy

Block pricing

practice of charging different prices for different quantities or "blocks" of a good Example: an electric utility company may charge one rate for the first quantity block of electricity and a different rate for another block.

second solution to price ridgitey

price leadership One firm in an oligopoly may emerge as the leader - perhaps the largest firm or the oldest firm. All the other firms in the market will mimic price changes by the leader to avoid a price war and maintain tacit collusion

Elastic customers are

price sensitive

One solution to price ridgitey

price signaling Firm A may try to signal to Firm B that it wants to maintain collusion, but needs to change its price, by using a press release to say something like, "We are changing our prices due to industry-wide changes in cost structure"

two-part tariff

provides another means of extracting consumer surplus; consumers are charged both an entry fee and a usage fee. For instance, a golf club may charge an annual membership fee plus a fee for each usage of the course. Similarly, a telephone service provider may charge both an installation fee and a fee per minute of usage.

Equilibrium in dominant strategies"

refers to the equilibrium of a game where both firms have a dominant strategy.

Repeated vs one shot

repeated games are easier to collude

Consumers' surplus

s a measure of consumer welfare and is defined as the excess of social valuation of product over the price actually paid difference between value and price paid for the customer

A furniture store may intentionally scratch furniture to

sell to lower-demand customers from a "Scratch and Dent" room.

Game

situation in which players (participants) make strategic decisions that take into account each other's actions and responses.

for linear city, he Nash (what firms will actually do) is

socially optimal

optimal strategy

strategy that maximizes a player's expected payoff

what does a best-response function tell you?

t tells us what quantity a profit-maximizing firm should produce, given any quantity produced by the other firm.

Price discrimination brings consumer into the market if

the consumers reservation price is below the equilibrium price

Prisoners' Dilemma

The story behind the name goes like this: Two prisoners have been accused of collaborating in a crime. The police are holding them in separate cells and thus they cannot communicate with one another. The police are trying to get the prisoners to confess. If both prisoners confess, then they will each be given 5 years in jail. This is depicted in the top left cell of the "payoff matrix" given below. If neither prisoner confesses, then the police will have a hard time making their case; they will offer a plea bargain where each prisoner only receives 2 years in jail. If one prisoner confesses but the other doesn't, then the one who confesses gets a good deal of only 1 year in jail; however, the prosecutor will go for the maximum sentence of 10 years for the prisoner who did not confess.

Payoff:

Value associated with a possible outcome.

1st degree price discrimination is not an option when

(i.e. the producer cannot tell which customer is Bob and which is Tom)

"price rigidity").

. Firm A might, therefore, keep its price the same to avoid "rocking the boat" even though it is not optimal

dominant strategy

A player has a dominant strategy when he should always play the same strategy (i.e. his best response is always the same, regardless of which choice his opponent makes).

price wars results in the

Bertrand model

Repeated games

If several firms compete over many periods (e.g. months), they may be able to maintain collusion and agree not to steal the market from one another (even if they never actually speak about it, which would be illegal).

Nash Equilibrium

Each firm is doing the best it can (i.e. maximizing profit) given what its competitors are doing. No firm has an incentive to change its behavior (i.e. change price or quantity) Each firm takes the actions of its competitors into account and assumes that its competitors are doing likewise. Nash equilibrium here means that no firm is better off changing its price or output.

Example of third degree

Examples include discounts to students or senior citizens and brand name versus generic goods. Airlines also place restrictions on low-fare tickets, such as requiring advance purchase or a Saturday night stay, in order to separate business travelers (whose companies are usually willing to pay higher fares) from vacationers.

Examples of oligarchy market

Examples: automobiles, computers, home improvement stores

Deviation (or "defection") from collusion maximizes current profits, but if the rivals retaliate, it could mean lower profits in the long run.

For example: Suppose two auto manufacturers sell similar sedans. Suppose further that they are tacitly colluding and thus earning higher profits than the Cournot outcome. Firm A knows that breaking collusion (i.e. by decreasing price or increasing quantity) will provide higher profits in the short run. However, Firm B will match the new price in the future and both firms will end up at the Cournot profit, possibly forever.

price discrimination

In some industries, firms may be able to split demand up into sections and charge different prices to different customers.

For two consumers,

Instead, the firm should set the usage fee above marginal cost and set the entry fee equal to the remaining surplus of the consumer with the lower demand. The figure below illustrates this.

wo consumers, but the firm can only charge one entry fee and one usage fee. two part tariff

It is no longer optimal for the firm to set the usage fee equal to marginal cost; if it did, it could make the entry fee no larger than the surplus of the consumer with the smaller demand. This would not maximize profit. Instead, the firm should set the usage fee above marginal cost and set the entry fee equal to the remaining surplus of the consumer with the lower demand. The figure below illustrates this. o find the exact profit-maximizing values for P and T in this case, the firm would need to know both demand curves and use calculus to maximize profit. set entry fee = to mc

Choosing Location

Nash eqilibirum is in the middle right next to eachother Politicians often move toward the middle of the "Conservative"/"Liberal" spectrum ("ideology space") as an election year approaches. They are trying to maximize votes. Airlines move toward the middle of time ranges for their flights. They are trying to maximize passengers.

Explain why the Cournot solution is a Nash equilibrium.

Neither firm wants to change its output from this equilibrium; doing so would result in a decrease in profit.

The Bertrand and Cournot models are different ways to characterize firm behavior.

No one model can predict what the firms in a particular market will do. However, we can see different incentives that the firms might face using these models. For instance, firms may be successfully tacitly colluding on quantity for a period of time, but then one firm lowers its price slightly. This may trigger a price war and both firms end up charging a price equal to marginal cost.

For example, consider a firm that offers a coupon for a 20% discount on a particular day. Coupons are a way to separate the consumers.

The "elastic"/"price sensitive" consumers will take the time to save the coupon and arrive on the correct date to purchase items with the coupon. The "inelastic"/"price insensitive" consumers will not bother to save the coupon. The firm wants the "elastic" consumers to pay a lower price; these consumers will buy more items and overall spend more money when prices are low. The coupon is essentially making their prices lower. The firm wants the "inelastic" consumers to pay a higher price; these consumers will buy less items, but will spend more money overall when prices are high. To ensure that the "inelastic" consumers don't get low prices, the firm requires the coupon for the discount, which the "inelastic" consumers are unlikely to save and remember to bring to the store.

Tit-for-tat strategy:

Repeated-game strategy in which a player responds in kind to an opponent's previous play, cooperating with cooperative opponents and retaliating against uncooperative ones In other words, I will cooperate until my rival defects; then I will defect as well. I will cooperate again if my rival takes a hit and increases his price.

Second-degree price discrimination definition 3

Second-degree price discrimination is the practice of charging different consumers different prices based on the characteristics of the purchase (rather than characteristics of the consumer - see third-degree price discrimination below). For instance, prices may differ based on the timing of the purchase or the quantity purchased.

Second-degree price discrimination Defenintion 1

Second-degree price discrimination is the practice of charging different prices per unit for different quantities of the same good or service. For example, in some markets, as a consumer purchases many units of a good over a given period, his reservation price declines with the number of units purchased (e.g. the price per ounce for breakfast cereal is likely to be smaller for the 24-ounce box than for the 16-ounce box). buying in bulk gives a discount

How do the firms reach a collusive price (or quantity) to start with?

Since they cannot communicate directly, it may be difficult, especially if the firms have different cost structures. Further, if a collusive price is reached and even maintained for some time, the firms will go through another difficulty if market conditions change (e.g. input prices change or demand changes). Thus, many times tacit collusion is short-lived.

Third-degree price discrimination definition 2

Third-degree price discrimination is the practice of charging different prices based on the characteristics of the consumer (as opposed to characteristics of the purchase).a

Third-degree price discrimination defenitintion 1

Third-degree price discrimination is the practice of dividing customers into two or more groups with separate, recognizable demand curves, and charging different prices to each group.

Why is Cable tv negatively correlated?

This is because there are only 24 hours in a day and consumers can only watch one channel at a time; a consumer who spends most of his time watching channel A cannot possibly spend most of his time watching channel B. cant watch two channels at same time

Bertrand model

Unlike the Cournot model, the Bertrand Model characterizes a situation where firms compete on price (choose price). In the Cournot model, the market price is the same for both firms, whereas the firms can choose different prices in the Bertrand model.

Know how to determine a firm's revenue when it prices products separately and when it prices products as a bundle. When price separately? When priced bundle?

When priced separately, take lowest price for each item and add them together When priced bundle, add the price for each item together for each firm. Then you charge the price of the lowest possible bundle

"Cournot equilibrium

When the reaction functions or best response function intersect, this point tells us that each firm is "best responding" to the other firm. Thus, we have a Nash equilibrium at (4,4)

aa

aaa

Defining second- and third-degree price discrimination

all economists seem to agree on the definition of first-degree price discrimination, different textbooks define second and third degree price discrimination differently. Thus, several possible definitions are provided for each. The definitions are similar, but not exactly the sa

Note that an equilibrium in dominant strategies is a

also a Nash equilibrium

Positibvly correlated is when the price is

when firm a is willing to pay a higher price for each part of the bundle

Bertrand Model CONSUMER will always purchase from the firms

with the lowest price