1Chapter 11MonopolyMonopoly• monopoly: only supplier of a good for which there is no close substitute• monopoly's output is the market output: q = Q• monopoly's demand curve is market demand curve• its demand curve is downward sloping• it doesn't lose all its sales if its raises its price• it is a price setterSolved ProblemMonopoly faces a constant elasticity demand curve (elasticity = ε) and a constant marginal cost = m. By how much does the price change if the marginal cost increases?Answer• in equilibrium, MR = p(1 + 1/ε) = m = MC•so p = m/(1 + 1/ε)• consequently, ∆p = ∆m/(1 + 1/ε)• thus, ∆p/∆m = 1/(1 + 1/ε) > 1• for example, if ε = -2, then ∆p/∆m = 1/(1 + 1/[-2]) = 2 Follow-up questions• What’s the implication of the previous analysis for the consumer incidence of a specific tax?• How would your answers change if the demand curve were linear?Generalizing• we can use the monopoly model to look at many other models• regulated monopoly• dominant firm/competitive fringe• oligopoly• we determine the residual demand facing a firm, which then acts like a monopoly with respect to the residual demand2Chapter 12PricingNonuniform pricing• prices vary across customers or units• noncompetitive firms use nonuniform pricing to increase profits Successful price discrimination• requires that firm have market power • consumers have different demand elasticities, and firm can identify how consumers differ• firm must be able to prevent or limit resales to higher-price-paying customers by others3 types of price discrimination• perfect price discrimination (first-degree): sell each unit for the most each customer is willing to pay • quantity discrimination (second-degree): charges a different price for larger quantities than for smaller ones• multimarket price discrimination (third-degree): charge groups of customers different pricesWhy firms use self-identification• each price discrimination method requires that, to receive a discount, consumers incur some cost, such as their time• otherwise, all consumers would get a discount• by spending extra time to obtain a discount, price-sensitive consumers differentiate themselves from othersOther forms of nonlinear pricing• two-part tariffs• tie-in salesboth are second-degree price discrimination schemes where the average price per unit varies with the number of units consumers buy3Two-part tariff• firm charges a consumer • lump-sum fee (first tariff) for right to buy any units• constant price (second tariff) on each unit purchased • because of lump-sum fee, consumers pay more, the fewer units they buy2 forms of tie-in sales• requirements tie-in sale: customers who buy one product from a firm must purchase all units of another product from that firm (copiers/toner or service)• bundling (or a package tie-in sale): two goods are combined so that customers cannot buy either good separately (shoes/shoelaces)Solved ProblemDoes a monopoly’s ability to price discriminate between two groups of consumers depend on its marginal cost curve? Why or why not?Answer• if the marginal cost is so high that the monopoly is uninterested in selling to one group, it acts like a pure monopoly with respect to the other group• if the marginal cost is low enough that it wants to sell to both groups, it will price discriminate iff the groups have different demand elasticities and it can prevent resaleChapter 13Oligopoly and Monopolistic CompetitionOligopoly• small group of firms in a market with substantial barriers to entry • because relatively few firms compete in such a market, • each firm faces a downward-sloping demand curve• each firm can set its price: p > MC• market failure: inefficient (too little) consumption• each affects rival firms• typical oligopolists differentiate their products4Monopolistic competition• small or moderate number of firms• free entry• π = 0• p = AC• usually products differentiatedNash equilibrium• set of strategies is a Nash equilibrium if, • holding strategies of all other players (firms) constant, • no player (firm) can obtain a higher payoff (profit) by choosing a different strategy• in a Nash equilibrium, no firm wants to change its strategy because each firm is using its •best response:• strategy that maximizes its profit given its beliefs about its rivals' strategiesFrequent Fliers• May 1981: American Airlines introduced AAdvantage, first frequent flier program• within days, United Airlines announced its own FFP, Mileage PlusTask• On your major route, your airline face onlyAmerican Airlines, which, before the introduction of the FFP, flies the same number of passengers as your airline and has the same costs • Your firm conducts a marketing study:market has a constant elasticity demand curve and that a FFP adopted by both firms would shift the elasticity of demand from –2 to –1.75Task (cont.)• FFP would raise the marginal cost (extra meals, extra fuel) per passenger from $150 to $160 per trip• assume both airlines set a single price for tickets (do not price discriminate) and engage in a Nash-in-quantities (Cournot) game • how will equilibrium prices change if both firms adopt the FFP?Analysis• if only one airline adopts a FFP, it gains many extra customers• however, if both introduce FFP, none may gain a substantial number of extra customers and all incur the extra costs of the program• does it follow that airlines are likely to lose money by using FFPs? Not necessarily5Analysis (cont.)• without FFPs, Kathy flies on whichever airline has the least expensive ticket• if both set the same fare, Kathy chooses randomly• if both airlines introduce FFPs and Kathy joins AA’s FFP, she prefers buying from AA, even if she has to pay slightly more than she would have to pay for a ticket from its rival• thus, due to this product differentiation, Kathy has a less elastic demand for AA: AA can charge moreAnalysis (cont.)• Equation 13.10:p = MC/[1 + 1/(nε)],• where MC = $150 is its marginal cost, n = 2 is the number of identical firms, and faces an elasticity of demand of ε = -2:p = $150/[1 + 1/(2 x –2)] = $200Analysis (cont.)• after FFPs: elasticity of demand facing each airline falls to ε = -1.5 and the marginal cost rises to $160, so the equilibrium price rises top = $160/[1 + 1/(2 x –1.75)] = $224• thus, FFPs cause price to rise both because each firm’s demand has
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