MACQUARIE Bw tines ECON 632 Intermediate Microeconomics Week 9: Price Discrimination & Oligopoly Price Discrimination and Condition Perfect Price Discrimination Group Price Discrimination Nonlinear Pricing Two-Part Pricing Oligopoly: Cournot and StackelbergBp acquare Price discrimination Price discrimination is practice in which a firm charges consumers different prices for the same good. There are three types of price discrimination: ° first-degree price discrimination * second-degree price discrimination ° third-degree price discrimination. The aim is for the firm to convert consumer surplus into profit. A price-discriminating firm earns a higher profit because: * it charges a higher price to customers who are willing to pay more than the uniform price, capturing consumer surplus * it sells to some people who were not willing to pay as much as the uniform price.Be vacouare Price discrimination: Conditions Three conditions: = A firm must have market power. = Consumers must differ in their sensitivity to price, and a firm must be able to identify how consumers differ in this sensitivity, that is consumers in the different market segments should have different price elasticity of demand and different willingness to pay = The firm must be able to prevent or limit resales, that is consumers should not be able to buy in the low price segment and sell in the high price segment.Be nacouane Types of Price Discrimination 1. Perfect price discrimination (first-degree price discrimination): a situation in which a firm sells each unit at the maximum amount any customer is willing to pay for it > prices differ across customers and a given customer may pay more for some units than for others > auctions approximate first-degree price discrimination. 2. Quantity discrimination (second-degree price discrimination): a situation in which a firm charges a different price for large quantities than for small quantities but all customers who buy a given quantity pay the same price. 3. Multimarket price discrimination (third-degree price discrimination): a situation in which a firm charges different groups of customers different prices but charges a given customer the same price for every unit of output sold.Ist~ clegee Perfect Price 1 Discrimination By useage Psul_= Parnraacrd willing to pay 2 MC = 2nd unit Gunoy ve to ia : ry FS 9 prom chews $5 ap tpg Mast unit « c$2O : PS = $) at quectely. soll : P= MC pt all otar uncts Solel » PME Demand, Marginal revenue a preeeeeabed Astunt * Gwaner willing fo $6 J” Pd 5) oS =O 6 ~~ , Units per = $-$t=$2 nd unit : P= $4= Me mo Ps % CS2O0 3 4 5Perfect Price Di MACQUARIE Efficien =O ° Aperfect price discrimination equilibrium is efficient and maximises total welfare: ce of the last unit sold is equal to the competitive it: mprice: — \> Pe MC pe gue Y The quantity sold is equal to the compe " tity. quently. > Qespisertt * Perfect price discrimination equilibrium differs from the competitive equilibrium in two ways: a Perfect price discrimination equilibrium, only the last unit is "~*~ sold at that price. > Perfectly price-discriminating monopoly captures all the ifare. — TS = PS (acs =o) >Competitive, Single-Price, and Bg Perfect Discrimination Equilibria cae monopoly equcl » Qat Mca mR MACQUARIE University ,$ per unit Me, Q, Q,=Qy Q, Units per day wnt > call unl PEMC Competition Single Price Discrimination ‘Consumer Surplus, CS A+B+C A o Producer Surplus, PS DtE B+D G+B+C+D+E ) A+B+C+D+E A+B+D A+B+C+D+£ Deadweight Loss, DWL 0 C+E 0wan liga Be ercouane Quantity Discrimination Pe University (a) Quantity Discrimination (b) Single-Price Monopoly =) Mane fT. MR=MC 5 90 !) Q<& 20 -) P= $10 5 90 IQ Coe A * “70 so0 x PS= 6, “ PS= $1209 @= (20:4) CS = $400 50 bro 2 P= $80 cS= An 30 30 0 20 40 / 90 0 Q, Units per day P . =) Dwl= But 2rel— olegree PO: P= $90, 2 =40 0D DUniversity Quantity Discrimination (ctd) Be wacusre Quantity Discrimination Single Price Consumer Surplus, CS A+C=$400 E= $450 Producer Surplus or Profit, PS = 1 B = $1200 F=$900 Welfare, W = CS + PS - A+B+ C= $1600 E+F=$1350 Deadweight Loss, DWL D=$200 G = $450 » Welfare improves with quantity discrimination but consumers are worse off. >» The more block prices the monopoly can set, the closer the monopoly can get to perfect price discrimination.me Bua Identifying groups; welfare * Two approaches to divide customers into groups: (i) divide buyers into groups based on observable characteristics of consumers. (ii) identify and divide consumers on the basis of their actions. * Multimarket price discrimination often results in inefficient production and consumption. ¢ Asaresult, welfare under multimarket price discrimination is often lower than that under competition or perfect price discrimination3nol- oligate Multimarket Price Discrimination Bg MACQUARIE ~p University — a) United States_ (b) United Kingdom —_— 5 XN Me, = 5 In cach markt: o ne MC 35 x 29 oe ] Fiam clctormincd MRg = MC the Q be sellat MR = MC are then P Aerie on the 0 Curve . 9.4 19.47 22 453 or Million sets per year Q,, Million sets per yearTwo-Part Tariffs mg MACQUARIE * Two-part tariff is a pricing system in which the firm charges a jo < customer a lump-sum fee (the first tariff or price) for the right to po buy as many units of the good as the consumer wants at a we specified price (the second tariff). | P= MC * Two-part tariffs capture consumer surplus and turn it into profit. * Amonopoly that knows its customers’ demand curve can set a two-part tariff that has the same two properties as the perfect price discrimination equilibrium: - The efficient quantity, Q,, is sold because the price of the last unit equals marginal cost. - All consumer surplus is transferred from consumers to the firm.Two-Part Tariffs (ctd) BB acousne 2 i@ = MC= FIO neclucer Pures, (a) Consumer1 Waco i (b) Consumer 2 f 2 f “f ‘ 2) true fe = OS : to dat dorgue PD aL fae ewne = S2tsoy oO 60 70 80 0 . 80 90 100 q,, Units per day %, Units per day9 Py mer MC S610 Assume ihthacl P= $20 @ = 70. Q = 60 CS= A, = $1900 / PS= 6, = $600 2) Poocluarr charg Fou the sed fee , proctor ewok CS also chearoph at CS 2 Pacelucer cap hones all CS uel fe = $1900 es = $2,450. 450 =) Mo, —— Tok PS = #600 + $1¥00 = $2400Tie-In Sales BB icon * Another type of nonuniform pricing is a tie-in sale, in which customers can buy one product only if they agree to purchase another product as well. * 2 types of tie-in sales: * Requirement tie-in sale: customers who buy one product from a firm are required to make all purchases of related products from that firm. Example: Photocopying machine buyers buy services and supplies from same company. * Bundling: two goods are combined so that customers cannot buy either good separately. Example: refrigerators are sold with shelves.Bg MACQUARIE “p University Oligopoly + Small number of firms with substantial barriers to entry. * Each can influence the price and each affects rival firms > need to consider the behavior of rival firms when making a profit-maximixing decision. * If oligopolistic firms collude/coordinate their activities, a cartel is formed, and the members of a cartel earn the monopoly profit (the highest possible profit). * If they don’t collude, they earn lower profits > Non- cooperative oligopoly.. . Bp acousre Non-cooperative Oligopoly * Three models: Cournot model; Stackelberg model; Bertrand model. * Three restrictive assumptions: (i) all firms are identical in the sense that they have the same cost functions and produce identical, undifferentiated products. (ii) We initially illustrate each of these oligopoly models for a duopoly. (iii) the market lasts for only one period. * Duopoly equilibrium — a set of actions taken by the firms is a Nash equilibrium if, holding the actions of all other firms constant, no firm can obtain a higher profit by choosing a different action.MACQUARIE Cournot Model BB aces Four assumptions: 1. there are two firms and no other firms can enter the market 2. the firms have identical costs S mow Toa Q 3. they sell identical products = P= 4. the firms set their quantities(simultaneously. ) af ite same Ame_ * Example: Two airlines compete for customers on flights in a certain route. — “Cournot equilibrium (Nash-Cournot equilibrium) — a set of quantities sold by firms such that, holding the quantities of all other firms constant, no firm can obtain a higher profit by choosing a different quantity. ° Residual demand curve — the market demand that is not met by other sellers at any given price. 0, = Derectet = Buel by offer AisBp macoure Australis’s Profit-Maximising Output @) wd (b)Ducpoy 2 ASeuer that Utypeantine. 3 ‘ sowe 64 (towcarel ) 7 - >» O- for fushal, = i 21 - D- 44 = 0-64 & = 211 147 147 5 ‘ MC 0 96 169.5 339 0 64 128 137.5 275 339 a. Thousand Australis Airlines a, Thousand Australis Airlines passengers per quarter passengers per quarterSolve for Cournot Equilibrium for BB acouare the two airlines: Market demand: Q = Qa + Qu=339-P =) P= 339-Ga- Gy ——— For each airline: MC= AC = $147 Find the Cournot Equilibrium quantity for each airline. Aselis : Moc MT : MR = MC TT 2 TR= GaP = Gal 339- Ga ~ Gy) = 389Ua~ by’ Gaby MR =e ie = 339- 2@a- Qu = MC = [4B 339 -2Qa-Qu = |4F 20a = 192 -Gy fer ProdrotesSimi derlay » the aecchen Aunchr Aer Utopion « Cus 96- as (96-05 dy) = 96-49+t 02S5Qy tS Gy = 48 2 Qu = Bae ae = bF Qa Ola = 96-ASx 64 =L4 L ‘Ea uA aa" wl Glockebler 4 4 RFwy MACQUARIE University Stackelberg Oligopoly Model Suppose that one of the firms in our previous example was the leader and set its output before its rival, the follower. The leader realizes that once it sets its output, the rival firm will use its best-response curve to select its best-response output. Thus the leader predicts what the follower follower acts. do before the Using this knowledge, the leader chooses its output level to manipulate the follower, thereby benefiting at the follower’s expense.“ie By cay Solve for Stackelberg Equilibrium Assume Australis is the leader > it mou, put to chime Qa > Australis’s residual demand D(r) = D — Qu, where Qu is the Utopia’s best-response curve. Ba Dp = 339-P - (96-05 0a) Ga = 245-P+0S8q | R= PxOla P= 244- aS Qa a ( Prstootis 2s agicld, olomanl ) = 243Qa - aS Gy =) MR, = 248 -Qa ot His equal b MC 245-Wa = 144 2D Qa = 36 => sub into Ufopa RF -) Qy = 484, Thousand Utopia Best-Response Curves, Cournot & FJ Stackelberg Equilibria MACQUARIE University passengers per quarter 192 Australis’s best-response curve 96 64 feccseeseesee nS Cournot equilibrium Stackelberg ee Equilibrium Utopia’s best-response curve 0 64 96 192 qx. thousand Australis passengers per quarterBF tacare Bertrand Model * Bertrand Equilibrium: a set of prices such that no firm can obtain a higher profit by choosing a different price if the other firms continue to charge these prices. aunel compete in tad 4 Ps + Bertrand equilibrium with identical products: as the firm with the P>NC /- lowest price will achieve 100% market share, firms will undercut the prices of rival firms until price is driven down to the firm’s marginal cost. > The Bertrand equilibrium when firms produce identical products is the same as the price-taking, competitive equilibrium. > Same om Fe Aton: PE MC , then adel ee e Arm chow Q t+ MR=McPBp acquare Bertrand Model * Bertrand equilibrium with differentiated products: Firms set price above MC and according to demand con ns. The equilibrium is where the Bertrand best-response curves cut each other. Ls nacho functor in > The Cournot best-response curves plot relationship between farm quantities, and slope downward, showing that a firm produces 4 puss less the more its rival produces. > The Bertrand best-response curves plot relationship between prices, and slope upward, indicating that a firm charges a higher price, the higher the price its rival charges. RFo RF,