Pricing Strategies for Monopolist
• We have assumed so far that the
monopolist charges the same price to
every buyer
• If the monopolist can set different prices
for different customers, it can be shown
that this enables her to increase her profit.
Examples
• Pricing of cinema hall tickets by time of
day
• Pricing of transport services by age
• Pricing of professional services by income
categories
• Pricing of goods by different degrees of
recognition or frequency of purchase
• Pricing of books by different editions
• Pricing by region
When resale is not possible
• Services
• Warranties – The firm can void a warranty
if the object is resold
• Transaction cost
• Contractual remedies
• Vertical integration
• Government intervention
Price discrimination
• Price discrimination:
different buyers are charged different unit
prices for similar goods, and the prices are
in different ratios to marginal costs.
Conditions for Successful Price
Discrimination
• The firm must have some degree of
market power, i.e., the ability to set
prices.
• The firm must be able to separate
customers into two or more groups.
• The firm must be able to prevent arbitrage
by buyers, i.e., resale by buyers
Three degrees of price discrimination
• First-degree or perfect price discrimination
• Second-degree or nonlinear pricing
• Third-degree price discrimination
1

Why three degrees?
• How much information does the seller
have about buyers?
1. Perfect information – seller knows the
type of each and every buyer
2. Seller knows the distribution of buyer
types, not individual buyers
3. Seller can identify buyer types by
categories
First-degree or perfect price
discrimination
• The seller has perfect information about
the demand curves of buyers.
• For each unit sold, the seller charges the
buyer an amount equal to the maximum
willingness to pay for that unit.

Example First-degree or perfect price

Buyer Maximum price
buyer is willing
to pay
A 10
B 9
C 8
D 7
E 6
MC = 8
discrimination
Total market
• Next, suppose that each consumer wants one
demand unit of a product, but consumers are willing to
pay different amounts.
• By ranking the consumers according to their
1 maximum willingness to pay and plotting the
2 aggregate demands, we get a downward sloping
aggregate demand curve.
3 • The firm then charges each consumer the
4 maximum that the person is willing to pay and
sells to any customer whose maximum
5 willingness to pay exceeds or is equal to the
marginal cost.

First-degree or perfect price

discrimination p, $ per unit
p1

Results: A es
MC

1. From the efficiency standpoint, perfect

ps
B C ec
price discrimination gives the same result
pc =MC c
E

as perfect competition – no deadweight

D MCs

loss MC1
Demand, MR d

2. Distributional implications are totally MR s

Q s Qc=Q d Q, Units per day
different: CS = 0 and Seller captures all
consumer surplus

2
 Two-part tariff
• Use of two-part tariffs to achieve perfect
price discrimination
• A two-part tariff consists of:
- a fixed fee that buyers have to pay to be
allowed to purchase the commodity
(sometimes called the access fee)
- and a fixed per unit charge thereafter
Two-part tariffs fall under the category of
non-linear pricing
Two-Part Tariff with a Single Consumer
$/Q
Usage price P* is set where
T*
MC = D. Entry price T*
is equal to the entire
consumer surplus.
MC
P*
D • The monopolist then constructs a price
Quantity
Second-degree price discrimination
or nonlinear pricing
• Customers may be identified by their
willingness to spend time to buy a good at
a lower price or to order goods and
services in advance of delivery
• Firms use differences in the value
customers place on their time to
discriminate by using queues
Examples of two-part tariffs
1. Membership fees for clubs plus the price
of drinks and meals
2. The entrance fee to the zoo together
with separate fees for entering the
reptile house and other exhibits
3. Monthly rentals for telephones plus
payment for calls. etc.
Second-degree price discrimination
or nonlinear pricing
• We assume that the monopolist will not be
able to identify the type of a particular
buyer, though she may have a good idea
about the distribution of buyer types
schedule in such a way that buyers reveal
their types by choosing points on the
schedule – “self-selection”
Getting customers to identify
themselves
Coupons
- People who use coupons are more price-
sensitive on average than those who don’t
clip coupons
Airline tickets
- Choice between high-price tickets with no
strings attached and low-price fares with
various kinds of restrictions
3
 Non-linear pricing
• Buyers face nonlinear price schedules, i.e.,
the price paid depends on the quantity or
quality bought
• Sometimes differences in quality, too, get
reflected in a nonlinear manner in prices -
The price difference between a high
quality and a low quality good is more
than that can be explained by differences
in quality alone.
Non-linear pricing
• Uniform price to all customers:
Total revenue = pQ
• Non-linear pricing via a price-schedule:
p = 10 – Q
Q p
1 9
2 8
3 7 etc.
Third-degree price discrimination
Different groups of buyers are charged different
prices.
• Suppose that the buyers can be separated
into two groups, with inverse demand curves
P1(Q1) and P2(Q2), respectively.
• The monopolist’s cost function is C(Q1 + Q2).
• The monopolist tries to maximize the joint
profit from the two groups of buyers :
Π = [P1(Q1)] (Q1) + [P2(Q2)](Q2) - C(Q1 + Q2)
Quantity discounts
• Most customers are willing to pay more for
the first units than for the successive units
• Firm can price-discriminate by letting the
price each customer pays vary with the
number of units the customer buys
• Use of a price-schedule
• Implies quantity discounts
Non-linear pricing
• Incentive compatibility constraint
- The seller must make sure that the offer
aimed at a type A is not found attractive by
a type B, say.
• Individual rationality constraint
- Each buyer of a certain type must find the
appropriate price sufficiently attractive to
buy the product.
Third-degree price discrimination
• The first order conditions are
dΠ/dQ1 = dΠ/dQ2 = 0.
• These yield the conditions
MRi(Qi) – MC(Q1 + Q2) = 0, i = 1,2.
The conditions can be written alternatively as
MR1(Q1) = MR2(Q2) = MC(Q1 + Q2)
4
 Third-degree price discrimination
• Also, MRi = Pi(1 – 1/ei)
• Then MR1(Q1) = MR2(Q2) =>
P1/P2 = (1 – 1/e2)/(1 – 1/e1)
= (e1e2 - e1)/ (e1e2 – e2).
1. Prices charged to the two groups of
buyers are equal if the price elasticities
are equal.
2. Otherwise, P1 > or < P2 according as
e1 < or > e2.
Durable Goods Monopolies
• Durable goods do not perish even after
repeated usage.
• Monopolist is then tempted to charge a
lower price in the future – temporal price
discrimination
• But buyers should be able to anticipate
this and postpone their purchase

Durable Goods Monopolies Durable Goods Monopolies

Coase (1972) had conjectured that
• if the time periods are short enough
• and the consumers can rationally
anticipate buyer’s actions,
then the price might immediately drop down
to the level of marginal cost and the
monopolist forfeit all market power.
Solutions:
1. Rent/lease rather than sell. Why might this not
be feasible?
2. Produce less durable goods
3. Ensure that future production is prohibitively
costly
4. Guarantee to buy back the good in the future
from any consumer at the price they paid for it.
This is sometimes not possible because
consumer usage can change the nature of the
good or lower its value.
5. Acquire a reputation for never lowering its
prices

Bundling Bundling
• Two or more commodities are sold only in • Pure Bundling
fixed proportions. • 100 buyers of each type
• Pure vs. mixed bundling • Zero costs
Pencil Box Sharpener Total
Type 1 24 2 26
Type 2 22 3 25
No bundling Bundling
Total revenue 4400+400 25x200

5
 Bundling
• Reservation prices are positively correlated

Pencil Box Sharpener Total

Type 1 24 3 27
Type 2 22 2 24
No bundling Bundling
Total revenue 4400+400 = 24x200