Chapter 26 - Monopoly behavior: Second-degree price discrimination

second degree price discrimination graphs: What is one further thing a monopolist can do to increase profits?

- Suppose that instead of offering x01 at price A to the low demand consumer, the monopolist offers a bit less than that at a price slightly less than A this reduces the monopolist's profits on person 1 by the small colored triangle illustrated in figure 26.3B but, since person 1's package is now less attractive to person 2, the monopolist can now charge more to person 2 for x02

draw graphs to show second price discrimination

- refer to book

explain the graphs

- these are the demand curves of two consumers; the producer has zero marginal cost by assumption - panel A is the self selection problem - panel B shows what happens if the monopolist reduces the output targeted for consumer 1 - Panel C illustrates the profit maximizing solution

EXAMPLE: Price discrimination in Airfares: how do airlines implement price discrimination?

- they offer an unrestricted fare for business travel and a restricted fare for non business travel - the restricted fare often requires advanced purchase or other such impositions - the point of such impositions is to be able to discriminate between the high demand business travelers and the more price sensitive individual travelers - by offering a degraded product, the restricted fares, the airlines can charge the customers who require flexible travel arrangements considerably more for their tickets - such arrangements may well be socially useful; without the ability to price discriminate, a firm may decide that it is optimal to sell only to the high demand markets

second degree price discrimination graphs: there is one further thing a monopolist can do to increase profits- Suppose that instead of offering x01 at price A to the low demand consumer, the monopolist offers a bit less than that at a price slightly less than A this reduces the monopolist's profits on person 1 by the small colored triangle illustrated in figure 26.3B but, since person 1's package is now less attractive to person 2, the monopolist can now charge more to person 2 for x02 -> by reducing x01, the monopolist makes area A a little smaller but makes area C bigger the net result is that the monopolist's profits increase -> continuing in this way, the monopolist will want to reduce the amount offered to person 1 up to he point where profits lost on person 1 due to a further reduction in output just equals the profit gained on person 2. at this point, the marginal benefits and costs of quantity reduction just balance person 1 chooses xm1 and is charged ..... and person 2 chooses x02 and is charged ................... person 1 ends up with ....... surplus and person 2 ends up with a surplus of ........ just what he would get if he chose to consume .....

A A+C+D zero surplus B xm1

second degree price discrimination graphs: one thing the monopolist can do is to offer x02 at a price A+C. In this case, the high demand consumer finds it optimal to choose X02 and receive a gross surplus of A+B+C he pays the monopolist A+C, which yields a net surplus of .... for consumer 2 - just what he would get if he chose x01

B

EXAMPLE: Price discrimination in Airfares: state another way that airlines can price discriminate

first class and coach class travel - first class travelers pay more for tickets but receive an enhanced level of service. - coach class receive lower level of service - this sort of quality discrimination has been around for a long time.

second degree price discrimination graphs: there is one further thing a monopolist can do to increase profits- Suppose that instead of offering x01 at price A to the low demand consumer, the monopolist offers a bit less than that at a price slightly less than A this reduces the monopolist's profits on person 1 by the small colored triangle illustrated in figure 26.3B but, since person 1's package is now less attractive to person 2, the monopolist can now charge more to person 2 for x02 -> by reducing x01, the monopolist does what?

makes area A a little smaller but makes area C bigger the net result is that the monopolist's profits increase

why is it also known as non-linear pricing?

means that the price per unit of output is not constant by depends on how much you buy

second degree price discrimination graphs: one thing the monopolist can do is to offer x02 at a price A+C. In this case, the high demand consumer finds it optimal to choose X02 and receive a gross surplus of A+B+C he pays the monopolist A+C, which yields a net surplus of B for consumer 2 - just what he would get if he chose x01 This generally yields more profit to the monopolist than it would get by offering only ............................

one price quantity combination

what is the main problem with the first degree price discrimination example?

person 1 - the high willingness to pay person - can pretend to be person 2, the low willingness to pay person. the seller may have no effective way to tell them apart

this form of price discrimination is commonly used by ...................

public utilities

second degree price discrimination graphs: in practice, the monopolist often encourages this self selection not by adjusting the ......... of good but rather by adjusting the .......... of the good

quantity quality

second degree price discrimination graphs: in general, the monopolist will want to reduce the quality offered to the low end of its market. Why?

so as not to cannibalize sales at the high end

second degree price discrimination is also known as what?

the case of non-linear pricing

in order to set the right prices, the monopolist must know what?

the demand curves; the monopolist has to know the exact willingness to pay of each person.

second degree price discrimination graphs: the monopolist would like to offer x01 at price A and to offer x02 at price A+B+C this would capture all the surplus for the monopolist and generate the most possible profit unfortunately, for the monopolist, these price quantity combinations are not compatible with self selection. Why?

the high demand consumer would find it optimal to choose the quantity x01 and pay price A: this would leave him with a surplus equal to area B, which is better than the zero surplus he would get if he chose x02

second degree price discrimination graphs: there is one further thing a monopolist can do to increase profits- Suppose that instead of offering x01 at price A to the low demand consumer, the monopolist offers a bit less than that at a price slightly less than A this reduces the monopolist's profits on person 1 by the small colored triangle illustrated in figure 26.3B but, since person 1's package is now less attractive to person 2, the monopolist can now charge more to person 2 for x02 -> by reducing x01, the monopolist makes area A a little smaller but makes area C bigger the net result is that the monopolist's profits increase -> continuing in this way, the monopolist will want to reduce the amount offered to person 1 up to he point where profits lost on person 1 due to a further reduction in output just equals the profit gained on person 2. at this point, what balances?

the marginal benefits and costs of quantity reduction just balance

second degree price discrimination graphs: without the low end consumers the high end consumers would have zero surplus.It is beneficial to the high end consumers to have low end consumers present. Why?

this is because the monopolist has to cut the price to the high end consumers to discourage them from choosing the product targeted to the low end consumers.

second degree price discrimination graphs: the monopolist would like to offer x01 at price A and to offer x02 at price A+B+C what would this do?

this would capture all the surplus for the monopolist and generate the most possible profit

EXAMPLE: Price discrimination in Airfares: what is the point of the reduced quality product?

to dissuade those with a high willingness to pay from purchasing the lower priced good

what is one way to get around the problem of first degree price discrimination?

to offer 2 different price quantity packages in the market - one package will be targeted towards the high demand person, the other package towards the low demand person - it can often happen that the monopolist can construct price-quantity packages that will induce the consumers to choose the package meant for them; in economics argon, the monopolist constructs price quantity packages that give the consumers an incentive to self select

EXAMPLE: Price discrimination in Airfares: what is the optimal pricing policy for a monopolist dealing with 2 groups of consumers?

to sell to the high willingness to pay market at a high price and offer a reduced quality product to the market with the lower willingness to pay

second degree price discrimination graphs: there is one further thing a monopolist can do to increase profits- Suppose that instead of offering x01 at price A to the low demand consumer, the monopolist offers a bit less than that at a price slightly less than A this reduces the monopolist's profits on person 1 by the small colored triangle illustrated in figure 26.3B but, since person 1's package is now less attractive to person 2, the monopolist can now charge more to person 2 for x02 -> by reducing x01, the monopolist makes area A a little smaller but makes area C bigger the net result is that the monopolist's profits increase -> continuing in this way, the monopolist will want to reduce the amount offered to person 1 up to what point?

up to the point where profits lost on person 1 due to a further reduction in output just equals the profit gained on person 2.

second degree price discrimination graphs: why is it beneficial to the high end consumers to have low end consumers present?

without the low end consumers the high end consumers would have zero surplus

second degree price discrimination graphs: one thing the monopolist can do is to offer x02 at a price A+C. In this case, the high demand consumer finds it optimal to choose ....... and receive a gross surplus of ......................

x02 A+B+C

second degree price discrimination graphs: without the high end consumers, the low end consumers would be offered higher quality, but they would still end up with ............

zero surplus