PRICING WITH MARKET

POWER
Price discrimination, Capturing consumer surplus,
Inter-temporal and peak load pricing
Chapter 11
Capturing Consumer Surplus
• A monopolist is able to charge a single price for all its
consumers
• Ideally, it would like to capture more CS by charging some
consumers a higher price
• And attract others by charging a lower price (while
continuing to charge a higher price for other consumers)
Price Discrimination
• Refers to the practice of charging different prices to
different consumers for similar goods.
• Each consumer has a reservation price which is the
maximum price that a customer is willing to pay
for a good.
• First degree price discrimination: Practice of charging
each customer her reservation price.
• Under FDPD, the firm produces quantity up to the point
where MC intersects the demand curve and captures the
entire consumer surplus.
Imperfect Price Discrimination
• In practice, firms don’t know the exact reservation price of
each consumer.
• Using their estimates of reservation prices, the firm
charges different consumers different prices
• Perfect FDPD is rare to observe but there might be
instances of imperfect FDPD where the firm charges
multiple prices based on its estimate of the consumer’s
reservation price
Second Degree Price Discrimination
• Entails charging different prices per unit for different
quantities of the same good or service.
• Block pricing - Practice of charging different prices for
different quantities or “blocks” of a good.
• Consumers consuming smaller quantities are charged
higher per unit price
• If the firm has economies of scale, and average and
marginal costs are declining, then SDPD is a good tool to
extract higher consumer surplus
Third Degree Price Discrimination
• Entails dividing consumers into two or more groups with
separate demand curves and charging different prices to
each group.
• Profit maximizing for the firm implies:
• Total output should be divided between the groups of customers so
that marginal revenues for each group are equal.
• The marginal revenue for each group of consumers is equal to the
marginal cost of production.
Third Degree Price Discrimination

Profit maximization implies

Note that price must be such that

Or the relative prices in the two markets must be:

Intertemporal Price Discrimination
• Consumers are divided into groups by changing the price
over time.
• Initially, the price is high. The firm captures surplus from
consumers who have a high demand for the good and
who are unwilling to wait to buy it.
• Later the price is reduced to appeal to the mass market.
• Eg: Mobile Phones, Books
Peak Load Pricing
• Demands for some goods and services increase sharply
during particular times of the day or year.
• Charging a higher price P1 during the peak periods is
more profitable for the firm than charging a single price at
all times.
• It is also more efficient because marginal cost is higher
during peak periods.
• IPD and PLD involve charging different prices at different
times but the reasons are different.
Difference from TDPD
• Under TDPD, marginal revenue for each group of
consumers and equal to marginal cost – serving the two
groups is interdependent
• Under peak-load and intertemporal price discrimination,
serving one group of consumers is independent of serving
the other group
• Eg: selling more electricity during off-peak periods will not
significantly increase the cost of selling electricity during
peak periods.
Example 1
Suppose the monopolist faces two markets where it
supplies simultaneously

What is the optimal quantity sold by the monopolist in the

two markets when MC = 4+Q?
Example 1 Solution
This is a case of third degree price discrimination. Hence it
must be that:

And:

Using these two equations we get:

Example 2
Suppose the monopolist faces two markets

What is the optimal quantity sold by the monopolist if the

monopolist sells to the different markets at different times
(intertemporal price discrimination) when MC = 4+Q?
Example 2 Solution
This is a case of intertemporal price discrimination where
production for the two markets is independent. Hence it
must be that:

And: