PM7e_PindyckRubinfeld_Microeconomics_Ch11ab.az.ch11

7/23/2019 PM7e_PindyckRubinfeld_Microeconomics_Ch11ab.az.ch11

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Fernando & YvonnQuijano

Prepared by:

© 2008 Prentice Hall Business Publishing • Microeconomics • Pindyck/Rubinfeld !e"

Pricing with

Market Power

11

# H $

P

% &

R



C h a p t e r 1 1 : P r i c i n g

w i t h M a r k e t P o w e r

2 of 41#o'yright © 200( Pearson &ducation )nc" Publishing as Prentice Hall • Microeconomics • Pindyck/Rubinfeld !e"

CHAPTER 11 OT!"#E

**"* #a'turing #onsumer +ur'lus

**"2 Price ,iscrimination

**"- )ntertem'oral Price ,iscrimination and Peak.oad

Pricing

**" %he %1o.Part %ariff

**" Bundling

**"3 $d4ertising





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#$P%5R)67 #6+5M&R +5RP5+**"*

Capt%ring Con&%'er (%rp)%&

*ig%re 11+1

)f a firm can charge only one 'rice forall its customers that 'rice 1ill be P 9and the :uantity 'roduced 1ill be Q9"

)deally the firm 1ould like to chargea higher 'rice to consumers 1illing to'ay more than P 9 thereby ca'turingsome of the consumer sur'lus underregion A of the demand cur4e"

%he firm 1ould also like to sell toconsumers 1illing to 'ay 'rices lo1erthan P 9 but only if doing so does notentail lo1ering the 'rice to otherconsumers"

)n that 1ay the firm could alsoca'ture some of the sur'lus underregion B of the demand cur4e"

, price di&cri'ination Practice ofcharging different 'rices to different

consumers for similar goods"






PR)#& ,)+#R)M)6$%)6**"2

;irst.,egree Price ,iscrimination

, re&er-ation price Ma<imum 'rice that a customeris 1illing to 'ay for a good"

, fir&t.degree price di&cri'ination Practice ofcharging each customer her reser4ation 'rice"

Additiona) Profit fro' Perfect *ir&t./egree

Price /i&cri'ination

*ig%re 11+2

Because the firm charges each consumer herreser4ation 'rice it is 'rofitable to e<'andout'ut to =99"

>hen only a single 'rice P9 is charged thefirm?s 4ariable 'rofit is the area bet1een themarginal re4enue and marginal cost cur4es"

>ith 'erfect 'rice discrimination this 'rofite<'ands to the area bet1een the demandcur4e and the marginal cost cur4e"

, -ariab)e profit +um of 'rofits on each incremental unit

'roduced by a firm@ i"e" 'rofit ignoring fi<ed costs"






PR)#& ,)+#R)M)6$%)6**"2

;irst.,egree Price ,iscrimination

*ir&t./egree Price /i&cri'ination inPractice

*ig%re 11+$

;irms usually don?t kno1 thereser4ation 'rice of e4eryconsumer but sometimesreser4ation 'rices can be roughlyidentified"

Here si< different 'rices arecharged" %he firm earns higher'rofits but some consumers mayalso benefit"

>ith a single 'rice P* there are

fe1er consumers"

%he consumers 1ho no1 'ay P or

P 3 enAoy a sur'lus"

Perfect Price /i&cri'ination

The additional profit from producing and selling an incremental

unit is now the difference between demand and marginal cost.

"'perfect Price /i&cri'ination





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PR)#& ,)+#R)M)6$%)6**"2

+econd.,egree Price ,iscrimination

, &econd.degree price di&cri'ination Practice of charging different'rices 'er unit for different :uantities of the same good or ser4ice"

, b)ock pricing Practice of charging different 'rices for different:uantities or blocksC of a good"

(econd./egree Price /i&cri'ination

*ig%re 11+4

,ifferent 'rices are charged fordifferent :uantities or blocksC ofthe same good" Here there arethree blocks 1ith corres'onding'rices P * P 2 and P -"

%here are also economies ofscale and a4erage and marginalcosts are declining" +econd.degree 'rice discrimination canthen make consumers better offby e<'anding out'ut and lo1eringcost"






PR)#& ,)+#R)M)6$%)6**"2

%hird.,egree Price ,iscrimination

, third.degree price di&cri'ination Practice of di4iding consumersinto t1o or more grou's 1ith se'arate demand cur4es and chargingdifferent 'rices to each grou'"

Creating Con&%'er 3ro%p&

)f third.degree 'rice discrimination is feasible ho1 should the firm decide1hat 'rice to charge each grou' of consumersD

1+ >e kno1 that ho1e4er much is 'roduced total out'ut should bedi4ided bet1een the grou's of customers so that marginal re4enues foreach grou' are e:ual"

2+ >e kno1 that total out'ut must be such that the marginal re4enue foreach grou' of consumers is e:ual to the marginal cost of 'roduction"






PR)#& ,)+#R)M)6$%)6**"2


, third.degree price di&cri'ination Practice of di4iding consumersinto t1o or more grou's 1ith se'arate demand cur4es and chargingdifferent 'rices to each grou'"

Creating Con&%'er 3ro%p&

511+16






PR)#& ,)+#R)M)6$%)6**"2


/eter'ining Re)ati-e Price&

511+26

Third./egree Price /i&cri'ination

*ig%re 11+0

#onsumers are di4ided into t1o grou's 1ithse'arate demand cur4es for each grou'"%he o'timal 'rices and :uantities are suchthat the marginal re4enue from each grou'is the same and e:ual to marginal cost"

Here grou' * 1ith demand cur4e D* ischarged P *

and grou' 2 1ith the more elastic demandcur4e D2 is charged the lo1er 'rice P 2"

Marginal cost de'ends on the total :uantity'roduced Q%"

6ote that Q* and Q2 are chosen so thatMR* E MR2 E M#"






PR)#& ,)+#R)M)6$%)6**"2


/eter'ining Re)ati-e Price&

#o (a)e& to ('a))er Market

*ig%re 11+

&4en if third.degree 'rice discriminationis feasible it may not 'ay to sell to both

grou's of consumers if marginal cost isrising"

Here the first grou' of consumers 1ithdemand D* are not 1illing to 'ay much

for the 'roduct"

)t is un'rofitable to sell to them becausethe 'rice 1ould ha4e to be too lo1 tocom'ensate for the resulting increase inmarginal cost"






PR)#& ,)+#R)M)6$%)6**"2

#ou'ons 'ro4ide a means of'rice discrimination"

+tudies sho1 that only about 20to -0 'ercent of all consumersregularly bother to cli' sa4e and

use cou'ons"Rebate 'rograms 1ork the same 1ay"

nly those consumers 1ith relati4ely 'rice.sensiti4edemands bother to send in the materials and re:uestrebates"

$gain the 'rogram is a means of 'rice discrimination"






PR)#& ,)+#R)M)6$%)6**"2

TA9!E 11+1 Price E)a&ticitie& of /e'and for &er& -er&%&

#on%&er& of Co%pon&

PR"CE E!A(T"C"T

Prod%ct #on%&er& &er&

%oilet tissue F0"30 F0"33

+tuffing/dressing F0"!* F0"(3

+ham'oo F0"8 F*"0

#ooking/salad oil F*"22 F*"-2

,ry mi< dinners F0"88 F*"0(

#ake mi< F0"2* F0"-

#at food F0"( F*"*-

;roGen entrees F0"30 F0"(

7elatin F0"(! F*"2

+'aghetti sauce F*"3 F*"8*

#reme rinse/conditioner F0"82 F*"*2

+ou's F*"0 F*"22

Hot dogs F0"( F0"!!





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PR)#& ,)+#R)M)6$%)6**"2

%ra4elers are often amaGed at the 4ariety of fares a4ailable forround.tri' flights from 6e1 ork to os $ngeles"

Recently for e<am'le the first.class fare 1as abo4e I2000@ theregular JunrestrictedK economy fare 1as about I*!00 ands'ecial discount fares Joften re:uiring the 'urchase of a tickett1o 1eeks in ad4ance and/or a +aturday night stayo4erK could

be bought for as little as I00"

%hese fares 'ro4ide a 'rofitable form of 'rice discrimination"%he gains from discriminating are large because different ty'esof customers 1ith 4ery different elasticities of demand'urchase these different ty'es of tickets"

TA9!E 11+2 E)a&ticitie& of /e'and for Air Tra-e)

*ARE CATE3OR

E)a&ticity *ir&t C)a&& nre&tricted Coach /i&co%nted

Price F0"- F0" F0"(

)ncome *"2 *"2 *"8






)6%&R%&MPR$ PR)#& ,)+#R)M)6$%)6 $6, P&$L.$, PR)#)67

**"-

)ntertem'oral Price ,iscrimination

, interte'pora) price di&cri'ination Practice of se'arating

consumers 1ith different demand functions into differentgrou's by charging different 'rices at different 'oints in time"

, peak.)oad pricing Practice of charging higher 'rices during'eak 'eriods 1hen ca'acity constraints cause marginal coststo be high"

"nterte'pora) Price /i&cri'ination

*ig%re 11+

#onsumers are di4ided into grou'sby changing the 'rice o4er time"

)nitially the 'rice is high" %he firm

ca'tures sur'lus from consumers1ho ha4e a high demand for thegood and 1ho are un1illing to 1aitto buy it"

ater the 'rice is reduced to a''ealto the mass market"




w i t h M a r k e t P o w e

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)6%&R%&MPR$ PR)#& ,)+#R)M)6$%)6 $6, P&$L.$, PR)#)67

**"-

Peak.oad Pricing

Peak.!oad Pricing

*ig%re 11+

,emands for some goods andser4ices increase shar'ly during'articular times of the day or year"

#harging a higher 'rice P * during

the 'eak 'eriods is more 'rofitablefor the firm than charging a single'rice at all times"

)t is also more efficient because

marginal cost is higher during 'eak'eriods"





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)6%&R%&MPR$ PR)#& ,)+#R)M)6$%)6 $6, P&$L.$, PR)#)67

**"-

Publishing both hardbound and 'a'erbackeditions of a book allo1s 'ublishers to 'ricediscriminate"

+ome consumers 1ant to buy a ne1bestseller as soon as it is released e4en if

the 'rice is I2" ther consumers ho1e4er1ill 1ait a year until the book is a4ailable in'a'erback for I*0"

%he key is to di4ide consumers into t1o grou's so that those 1ho are1illing to 'ay a high 'rice do so and only those un1illing to 'ay a high 'rice

1ait and buy the 'a'erback"

)t is clear ho1e4er that those consumers 1illing to 1ait for the 'a'erbackedition ha4e demands that are far more elastic than those of biblio'hiles"

)t is not sur'rising then that 'a'erback editions sell for so much less thanhardbacks"





r


%H& %>.P$R% %$R);;**"

, two.part tariff ;orm of 'ricing in 1hich

consumers are charged both an entry and ausage fee"

(ing)e Con&%'er

Two.Part Tariff with a (ing)e Con&%'er

*ig%re 11+7

%he consumer has demand cur4eD"

%he firm ma<imiGes 'rofit by settingusage fee P e:ual to marginal cost

and entry fee T 9 e:ual to the entiresur'lus of the consumer"





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%H& %>.P$R% %$R);;**"

Two Con&%'er&

Two.Part Tariff with Two Con&%'er&

*ig%re 11+18

%he 'rofit.ma<imiGing usage fee P 91ill e<ceed marginal cost"

%he entry fee T 9 is e:ual to thesur'lus of the consumer 1ith thesmaller demand"

%he resulting 'rofit is2T 9 JP 9 F M#KJQ* Q2K" 6ote that

this 'rofit is larger than t1ice the

area of triangle ABC "





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%H& %>.P$R% %$R);;**"

Many Con&%'er&

Two.Part Tariff with Many /ifferent Con&%'er&

*ig%re 11+11

%otal 'rofit π is the sum of the 'rofit from the

entry fee πa and the 'rofit from sales πs" Both

πa and πs de'end on T the entry fee"

%herefore

π E πa πs E nJT KT JP F M#KQJnK

1here n is the number of entrants 1hichde'ends on the entry fee T and Q is the rateof sales 1hich is greater the larger is n"

Here T 9 is the 'rofit.ma<imiGing entry feegi4en P " %o calculate o'timum 4alues for P and T 1e can start 1ith a number for P findthe o'timum T and then estimate the resulting'rofit"

P is then changed and the corres'onding T recalculated along 1ith the ne1 'rofit le4el"





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%H& %>.P$R% %$R);;**"

)n *(!* Polaroid introduced its +N.!0 camera"%his camera 1as sold not leased toconsumers" 6e4ertheless because film 1assold se'arately Polaroid could a''ly a t1o.'arttariff to the 'ricing of the +N.!0"

>hy did the 'ricing of Polaroid?s cameras andfilm in4ol4e a t1o.'art tariffD

Because Polaroid had a mono'oly on both its camera and the film onlyPolaroid film could be used in the camera"

Ho1 should Polaroid ha4e selected its 'rices for the camera and filmD )t

could ha4e begun 1ith some analytical s'ade1ork" )ts 'rofit is gi4en by

π = PQ + nT − C 1(Q) − C 2(n)

1here P is the 'rice of the film T the 'rice of the camera Q the :uantity offilm sold n the number of cameras sold and C *JQK and C 2JnK the costs of'roducing film and cameras res'ecti4ely"





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%H& %>.P$R% %$R);;**"

Most tele'hone ser4iceis 'riced using a t1o.'art tariffO a monthlyaccess fee 1hich mayinclude some free

minutes 'lus a 'er.minute charge foradditional minutes"

%his is also true for cellular 'hone ser4ice 1hich hasgro1n e<'losi4ely both in the 5nited +tates and around

the 1orld"Because 'ro4iders ha4e market 'o1er they must thinkcarefully about 'rofit.ma<imiGing 'ricing strategies"

%he t1o.'art tariff 'ro4ides an ideal means by 1hichcellular 'ro4iders can ca'ture consumer sur'lus and turn it

into 'rofit"





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%H& %>.P$R% %$R);;**"





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B56,)67**"

, b%nd)ing Practice of selling t1o or

more 'roducts as a 'ackage"%o see ho1 a film com'any can use customer heterogeneity to itsad4antage su''ose that there are t1o mo4ie theaters and that theirreser4ation 'rices for these t1o films are as follo1sO

)f the films are rented se'arately the ma<imum 'rice that could becharged for Wind is I*0000 because charging more 1ould e<clude

%heater B" +imilarly the ma<imum 'rice that could be charged forertie is I-000"

But su''ose the films are bundled " %heater A 4alues the 'air of filmsat I*000 JI*2000 I-000K and %heater B 4alues the 'air atI*000 JI*0000 I000K" %herefore 1e can charge each theaterI*000 for the 'air of films and earn a total re4enue of I28000"





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B56,)67**"

Relati4e aluations

>hy is bundling more 'rofitable than selling the films se'aratelyDBecause the relati!e !aluations of the t1o films are re4ersed"

%he demands are negati!ely correlated Qthe customer 1illing to 'aythe most for Wind is 1illing to 'ay the least for ertie"

%o see 1hy this is critical su''ose demands 1ere positi!elycorrelated Qthat is %heater A 1ould 'ay more for both filmsO

)f 1e bundled the films the ma<imum 'rice that could be chargedfor the 'ackage is I*-000 yielding a total re4enue of I23000the same as by renting the films se'arately"





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B56,)67**"

Relati4e aluations

Re&er-ation Price&

*ig%re 11+12

Reser4ation 'rices r * and r 2 for

t1o goods are sho1n for three

consumers labeled A B and C "

#onsumer A is 1illing to 'ay u' toI-"2 for good * and u' to I3 forgood 2"





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B56,)67**"

Relati4e aluations

Con&%'ption /eci&ion& ;hen

Prod%ct& Are (o)d (eparate)y

*ig%re 11+1$

%he reser4ation 'rices ofconsumers in region ) e<ceed the'rices P * and P 2 for the t1o

goods so these consumers buyboth goods"#onsumers in regions )) and )buy only one of the goodsand consumers in region ))) buyneither good"





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B56,)67**"

Relati4e aluations

Con&%'ption /eci&ion& ;hen

Prod%ct& Are 9%nd)ed

*ig%re 11+14

#onsumers com'are the sum oftheir reser4ation 'rices r * " r 2 1ith

the 'rice of the bundle P B"

%hey buy the bundle only if r * r 2

is at least as large as P B"



C h a p t e r 1 1 : P r i c i n g w i t h M a r k e t P o w e

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B56,)67**"

Relati4e aluations

Re&er-ation Price&

*ig%re 11+10

)n 5a6 because demands are 'erfectly 'ositi4ely correlated the firm does not gain bybundlingO )t 1ould earn the same 'rofit by selling the goods se'arately"

)n 5b6 demands are 'erfectly negati4ely correlated" Bundling is the ideal strategyQallthe consumer sur'lus can be e<tracted"




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B56,)67**"

Relati4e aluations

Mo-ie E<a'p)e

*ig%re 11+1

#onsumers A and B are t1o mo4ietheaters" %he diagram sho1s their

reser4ation 'rices for the films onewith the Wind and etting ertie#s

arter.

Because the demands are negati4elycorrelated bundling 'ays"




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B56,)67**"

Mi<ed Bundling

, 'i<ed b%nd)ing +elling t1o or more goods both as a'ackage and indi4idually"

, p%re b%nd)ing +elling 'roducts only as a 'ackage"

Mi<ed -er&%& P%re 9%nd)ing

*ig%re 11+1

>ith 'ositi4e marginal costs mi<edbundling may be more 'rofitable than'ure bundling"

#onsumer A has a reser4ation 'ricefor good * that is belo1 marginal costc *

and consumer D has a reser4ation'rice for good 2 that is belo1 marginalcost c 2"

>ith mi<ed bundling consumer A isinduced to buy only good 2 andconsumer D is induced to buy only

good * thus reducing the firm?s cost"




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B56,)67**"

Mi<ed Bundling

et?s com'are three strategiesO

1" +elling the goods se'arately at 'rices P * E I0 and P 2 E I(0"

2" +elling the goods only as a bundle at a 'rice of I*00"

$" Mi<ed bundling 1hereby the goods are offered se'arately at'rices P * E P 2 E I8("( or as a bundle at a 'rice of I*00"




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B56,)67**"

Mi<ed Bundling

Mi<ed 9%nd)ing with =ero Margina) Co&t&

*ig%re 11+1

)f marginal costs are Gero and if consumers?demands are not 'erfectly negati4ely correlatedmi<ed bundling is still more 'rofitable than 'urebundling"

)n this e<am'le consumers B and C are 1illing to'ay I20 more for the bundle than are consumers A and D"

>ith 'ure bundling the 'rice of the bundle is I*00">ith mi<ed bundling the 'rice of the bundle can beincreased to I*20 and consumers A and D can stillbe charged I(0 for a single good"




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B56,)67**"

Bundling in Practice

Mi<ed 9%nd)ing in Practice

*ig%re 11+17

%he dots in this figure are estimates ofreser4ation 'rices for a re'resentati4esam'le of consumers"

$ com'any could first choose a 'rice

for the bundle P B such that a diagonalline connecting these 'rices 'assesroughly mid1ay through the dots"%he com'any could then try indi4idual'rices P * and P 2"

7i4en P * P 2 and P B 'rofits can be

calculated for this sam'le ofconsumers" Managers can then raiseor lo1er P * P 2 and P B and see

1hether the ne1 'ricing leads tohigher 'rofits" %his 'rocedure isre'eated until total 'rofit is roughlyma<imiGed"




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B56,)67**"

;or a restaurant mi<ed bundlingmeans offering both com'lete dinnersJthe a''etiGer main course anddessert come as a 'ackageK and an la carte menu Jthe customer buys the

a''etiGer main course and dessertse'aratelyK"

%his strategy allo1s the la carte menu to be 'riced to ca'ture consumersur'lus from customers 1ho 4alue some dishes much more highly thanothers"

$t the same time the com'lete dinner retains those customers 1ho ha4elo1er 4ariations in their reser4ation 'rices for different dishes Je"g"customers 1ho attach moderate 4alues to both a''etiGers and dessertsK"




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B56,)67**"




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B56,)67**"

%ying

, tying Practice of re:uiring a customer to'urchase one good in order to 'urchase another"

>hy might firms use this kind of 'ricing 'racticeD

ne of the main benefits of tying is that it often allo1s a firm

to meter demand and thereby 'ractice 'rice discriminationmore effecti4ely"

%ying can also be used to e<tend a firm?s market 'o1er"

%ying can ha4e other uses" $n im'ortant one is to 'rotectcustomer good1ill connected 1ith a brand name"

%his is 1hy franchises are often re:uired to 'urchase in'utsfrom the franchiser"




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$,&R%)+)679**"3

Effect& of Ad-erti&ing

*ig%re 11+28

$R and MR are a4erage and marginalre4enue 1hen the firm doesn?t ad4ertiseand $# and M# are a4erage andmarginal cost"

%he firm 'roduces Q0 and recei4es a

'rice P 0"

)ts total 'rofit π0 is gi4en by the gray.

shaded rectangle"

)f the firm ad4ertises its a4erage andmarginal re4enue cur4es shift to theright"

$4erage cost rises Jto $#SK but marginalcost remains the same"

%he firm no1 'roduces Q* J1here MRS E

M#K and recei4es a 'rice P *"

)ts total 'rofit π* is no1 larger"




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%he 'rice P and ad4ertising e<'enditure A to ma<imiGe'rofit is gi4en byO

%he firm should ad4ertise u' to the 'oint that

= full marginal cost ofad4ertising

511+$6

Ad!ertising leads to increased output.

But increased out'ut in turn means increased 'roductioncosts and this must be taken into account 1hencom'aring the costs and benefits of an e<tra dollar ofad4ertising"

$,&R%)+)679**"3




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;irst re1rite e:uation J**"-K as follo1sO

6o1 multi'ly both sides of this e:uation by A/PQ the

ad4ertising.to.sales ratio", ad-erti&ing.to.&a)e& ratio Ratio of a firm?s

ad4ertising e<'enditures to its sales"

, ad-erti&ing e)a&ticity of de'and Percentagechange in :uantity demanded resulting from a *.'ercentincrease in ad4ertising e<'enditures"

$ Rule of %humb for $d4ertising

511+46

$,&R%)+)679**"3




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#on4enience stores ha4e lo1er 'riceelasticities of demand Jaround FK but theirad4ertising.to.sales ratios are usually lessthan those for su'ermarkets Jand are oftenGeroK" >hyD

Because con4enience stores mostly ser4ecustomers 1ho li4e nearby@ they may

$,&R%)+)679**"3

need a fe1 items late at night or may sim'ly not 1ant to dri4e to thesu'ermarket"

$d4ertising is :uite im'ortant for makers of designer Aeans 1ho 1ill ha4e

ad4ertising.to.sales ratios as high as *0 or 20 'ercent"

aundry detergents ha4e among the highest ad4ertising.to.sales ratios of all'roducts sometimes e<ceeding -0 'ercent e4en though demand for any onebrand is at least as 'rice elastic as it is for designer Aeans" >hat Austifies allthe ad4ertisingD $ 4ery large ad4ertising elasticity"




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PM7e_PindyckRubinfeld_Microeconomics_Ch11ab.az.ch11