study unit 11 pricing with market power. why and how is consumer surplus captured. how is price...
DESCRIPTION
Capturing consumer surplus How do firms with market power capture more consumer surplus and transfer it to the producer? – Pricing Strategies! Can achieve by charging different prices to different consumers and not just a single price. Basis for price discrimination: – Practice of charging different prices to different consumers for similar goods.TRANSCRIPT
Study Unit 11Pricing with Market Power
• Why and how is consumer surplus captured.• How is price discrimination used to capture
consumer surplus.• How is market power used to implement two-
part tariff.• Pricing strategy of bundling.• Use of advertising by firms.
Outcomes
Capturing consumer surplus
• How do firms with market power capture more consumer surplus and transfer it to the producer?– Pricing Strategies!
• Can achieve by charging different prices to different consumers and not just a single price.
• Basis for price discrimination:– Practice of charging different prices to different
consumers for similar goods.
Capturing consumer surplus
Capturing consumer surplus
• Problem:– How to identify different consumers?– How to get them to pay different prices?
Price discrimination
• Three broad forms:– First Degree Price Discrimination• Perfect Price Discrimination• Imperfect Price Discrimination
– Second Degree Price Discrimination– Third Degree Price Discrimination
First-Degree Price Discrimination
• If firm could → Charge maximum price customer willing to pay. = Reservation Price
• Assume consumer buy one unit.• Practice of charging reservation price
= First-degree price discrimination
First-Degree Price Discrimination
First-Degree Price Discrimination• How does this affect profit?– Add profit from each additional unit bought= Variable profit (Yellow)
• Perfect price discrimination:– Variable profit given for each unit = Demand curve – MC– Never possible!• Impossible to charge different price to different
consumers.• Firm usually doesn’t know reservation price.
First-Degree Price Discrimination
• Imperfect price discrimination:– Charging few different prices based on estimates of
reservation price– Used by doctors, lawyers, architects or accountants
First-Degree Price Discrimination
Second-Degree Price Discrimination• Consumer purchase many different units =
reservation price will decline• Example: water, heat, fuel and electricity• Willingness to pay decline with increased
consumption.– Conservation easier and more worthwhile if price
then high= Second-degree price discrimination
Practice of charging different prices per unit for different quantities of the same good or service
Second-Degree Price Discrimination
Second-Degree Price Discrimination
• Another example = Block pricing and quantity discounts
• Block Pricing: Practice of charging different prices for different quantities or blocks of a good
• Quantity discounts = Different prices for different quantities purchased.
Third-Degree Price discrimination
• Practice of dividing consumers into:– two or more groups – with separate demand curves, and – charging different prices for each group.
• Examples:– Regular vs. special airfares– Canned or frozen vegetables– Discounts to students or senior citizens
Third-Degree Price discrimination
• Which price to pay?– Create consumer groups:• According to socio-economic characteristics• Divide total output between groups• MR1=MR2=MC
– Determine relative price:• Relate to elasticity of demand• P1/P2 = (1+1/E2) / (1+1/E1)
Third-Degree Price discrimination
Third-Degree Price discrimination
• Not always worthwhile to sell to more than one group.– Demand too
small– MC to high
Intertemporal price discrimination• Practice of:– Separating consumers – With different demand functions into different groups– By charging different prices– At different points in time
• Example: – Higher price for first-run movie and lower price after
a year.– High price for hard-cover book and bring out a
paperback version later at a lower price
Intertemporal price discrimination
Peak-loading pricing
• The practice of:– Charging higher prices– During peak periods– When capacity constraints cause high MC
• Increase economic efficiency by charging price close to MC.
• Example of peak times:– Amusement park over weekends and holidays– Roads during morning and afternoon traffic
Peak-loading pricing
Two-part tariff
• Only need to know the definition on page 406• Leave page 407-413• Definition:– Form of pricing in which consumer is charged both
entry and usage fee.– Example: Amusement park entry fee and price
per ride.
Bundling• ‘Gone with the wind’ and ‘Getting Gertie’s
Garter’• Theatres had to lease both• Two films were bundled = sold as a package• Bundling:– The practice of selling two or more products as a
package.– Why bundle?• When customer has heterogeneous demands and firm
can’t price discriminate.
Bundling
• Used to firms advantage:– Reservation price for two films
– Rented separately: Max price $10 000 = Theatre B– Total revenue = $26 000– If bundled: A = $15 000 and B = $14 000– Thus charge $14 000 and revenue total = $28 000
Gone with the Wind Getting Gertie’s Garter
Theater A $12 000 $3 000
Theater B $10 000 $4 000
Relative valuations
• Why is bundling profitable?– Relative valuations of the two films are reversed– Thus, demand negatively correlated: Willing to
pay more for ‘wind’ than ‘Gertie’.– Why is this critical?• Make demand positively correlated• Describe preferences in next graph
Bundling
Bundling
Bundling
Bundling
Bundling
Mixed bundling
• Selling two or more goods both as a package and individually.
• Packaged price below separate price.• Pure bundling: Selling products only as a
package.• Mixed bundling ideal strategy for negatively
correlated demands.
Mixed bundling
Mixed bundling
Bundling in practice
• Buy vehicle and add-on’s: radio, sunroof, metallic colour, etc.
• When will manufacturers include add-on’s and when not.
• Going on vacation and paying for add-on’s: excursions, etc.
Bundling in practice
Tying
• Practice of requiring a customer to purchase one good in order to purchase another.
• Pure bundling a common form of tying.• Example: Sell copy machine and must get
paper.
Advertising
• Firms with market power have another important decision: How much to advertise?
• Advertising spending = A• Choose advertising expenditure to maximise
profit.
∏ = PQ(P,A) – C(Q) - A
Effects of Advertising