26. Monopoly Behavior
If a firm has some degree of monopoly power, it can use complicated pricing and marketing strategies to earn profits higher than that of firms in competitive market. It can try to differentiate its product from the products sold by its competitors to create extra preference for its product in the market thus enhance its market power even further than that allowed by technology alone.
In this chapter the topic of how firms can enhance and exploit their market power is explained.
26.1 Price Discrimination
Selling different units of output at different prices is called price discrimination. Three kinds of price discrimination are recognized.
First-degree price discrimination means that the monopolist sells different units of output for different prices and these prices may differ from person to person. This is also termed as the case of perfect
price discrimination.
In second-degree price discrimination, the monopolist sells different units of output for different prices, but every individual who buys the same amount or quantity of the good pays the same price. The prices differ across the units of the good bought, and not across people. A simple example
of this is bulk discounts or discount for higher quantity.
In third-degree price discrimination, the monopolist sells output to different people for different prices, but every unit of output sold to a given person sells for the same price. This means he quotes the same price to a buyer irrespective of the quantity bought. Also this can occur across categories of persons, For example, senior citizens’ discounts, student discounts come under this type of discrimination. .
26.2 First-Degree Price Discrimination
A producer who is able to perfectly price discriminate will sell each unit of the good at the highest price it will command, that is, at each consumer’s reservation price. Since each unit is sold to each consumer at his or her reservation price for that unit, there is no consumers’ surplus generated in
this market; all the surplus goes to the producer.
26.3 Second-Degree Price Discrimination
Second-degree price discrimination is also known as the case of nonlinear pricing, since it means that the price per unit of output is not constant but depends on how much you buy.
26.4 Third-Degree Price Discrimination
Two different consumer groups or markets are offered different prices.
The market with the lower elasticity of demand will have higher price. This is because, an elastic demand provide more profit as price is decreased. A firm that price discriminates will therefore set a low price for the price-sensitive group and a high price for the group that is relatively price insensitive. In this way it maximizes its overall profits.
26.5 Bundling
26.6 Two-Part Tariffs
26.7 Monopolistic Competition
26.8 A Location Model of Product Differentiation
26.9 Product Differentiation
26.10 More Vendors
Important Points
1. A monopolist has an incentive to engage in price discrimination of some sort.
2. Perfect price discrimination involves charging each customer a different take-it-or-leave-it price. This is a Pareto efficient allocation. (But consumer surplus will be low in this allocation)
3. If a firm can charge different prices in two different markets, it will tend to charge the lower price in the market with the more elastic demand (because elastic demand gives more profit on reducing price).
4. If a firm can set a two-part tariff, and consumers are identical, then it will generally want to set price equal to marginal cost and make all of its profits from the entry fee.
5. The industry structure known as monopolistic competition refers to a situation in which there is product differentiation, so each firm has some degree of monopoly power, but there is also free entry so that profits are driven to zero.
6. Monopolistic competition can result in too much or too little product differentiation in general.
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max p1(y1)y1 + p2(y2)y2 − c(y1 + y2).
y1,y2
The optimal solution must have
MR1(y1) = MC(y1 + y2)
MR2(y2) = MC(y1 + y2).
That is, the marginal cost of producing an extra unit of output must be equal to the marginal revenue in each market.
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