Why do monopolies charge different prices to different customers: price discrimination: eg mobile phone tariffs)

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Gwendolyn Jones
6 years ago
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1 Why do monopolies charge different prices to different customers: price discrimination: eg mobile phone tariffs) We have previously seen how a monopolist chooses his profit maximising output - Which is less than the output under perfect competition - And sells at a price higher than that under perfect competition - with super-profits being made - a loss of consumer surplus. - while charging a price > MC (economic inefficiency) That s bad, you might say. But it could be worse! And sometimes, under monopoly or even oligopoly, it is worse. The simple monopoly model assumes that there is one smooth pattern of market demand for the product with only one price prevailing, whatever the monopolist sets. In the real world, that is not the case in a whole variety of products. 1

2 Why might sellers try to segment a market? 1. For many products, there may be different kinds of buyers: - some are themselves producers, reuiring essential inputs; - others may be simply endusers of the product as ordinary consumers: hence their demand patterns may be uite different. 2. There may be time constraints: eg electricity, telecommunications and other industry inputs have to be used at certain times: no choice in the matter: peak rates and off-peak eg fascinating behaviour of airline ticket prices: discounts for early booking; then higher prices for travelers at the last minute; 2

3 Class societies 3. Most societies are segmented into economic, social or cultural classes with very different purchasing powers at their command: Upper classes do not want to associate with the ordinary people; essentially the same product (with slight differentiation) may be sold to these different classes of consumers, at very different prices. eg business class tickets and economy class. eg a stubby of beer sold in the Sheraton (6.50) Holiday Inn (5.00); USP Staff Club (2.50) eg grocery products sold at MH CC, RB Patel or Cost U Less or New World Supermarket. eg house prices in upper class area and exactly similar house in middle income area 3

4 The full market may look like this (eg mobile phone calls) Top end: prepared to pay high prices for this product: could not care about the price Bottom end: consumers who won t buy much if the price rises. MC D MR (no of calls) 4

5 For profit maximising monopoly: output Qm where MR= MC Price charged would be Pm: but there are consumers who are prepared to pay more. And many customers who are currently priced out of the market, but who could still contribute to extra profit for the monopolist- all those between points A and B on the demand curve. Pm A MC B Co D Qm MR (no of calls) 5

6 Smart monopolist: can he split the market into two? Into high end where customers prepared to pay more: And low end where the monopolist can charge lower prices As long as those on the upper end do not leave that market, to go to the other one. How do mobile companies separate out the high end? [bonus mark] Pm High demand Market 1 A MC Low Demand Market 2 B D Qm MR (no of calls) 6

7 Suppose market is segmented into two markets/sets of customers? Red lines represent higher demand market (higher, higher ) Blue lines represent lower demand market (lower, lower ) Q: Where would a monopolist choose to sell his first few units of output? Techniue: learn how to derive the aggregate MR curve: MRa. 7

8 eg Fisherman with crabs or high uality fish (salmon cod) Choice of selling to top Chinese restaurants r in the market. Where would the fisherman sell, if he had a small catch? And with a very large catch which is more than what the restaurants want? 8

9 Sells first units of output where MR is higher Green lines tell you in which market the monopolist sells first Until he reaches that MR level (point ) at which gives higher marginal revenue 9

10 After point, monopolist will alternate between and and sell wherever the MR is higher. i.e. for the purposes of our analysis, we can combine the two MR curves into one: is the critical point. 10

11 After point, need to add to, horizontally and sell wherever the MR is higher. i.e. for the purposes of our analysis, we can combine the two MR curves into one. 11

12 With down to point To get a kinked MRa curve After which the is added on. 12

13 Call aggregate MR curve MRa: green dotted line- kinked at point. For total profit maximising output: euate MRa to MC His MC and ATC curves are of course the same. A B C MRa 13

14 Call aggregate MR curve MRa: green dotted line- kinked at point. For total profit maximising output: euate MRa to MC A B C MRa 14

15 So how much will the monopolist sell altogether? All depends on where his MC curve intersects the aggregate MR curve MRa. Focus on the green and purple curves. Add the MC curve: point of intersection (point F) gives total output level. Qt. A B MRa MC R F Qt 15

16 And how much will the monopolist sell in each market? i.e. where FR cuts and. i.e. = = MRa = MC In market 1, he sells Q1 and in market 2, he sells Q2 A P1 B MRa MC R F Q2 Q1 Qt 16

17 And what will the monopolist charge in each market? Whatever the market will bear: in market 1, he charges P1 and in market 2, charges P2. A P1 B P2 MRa MC R F Q2 Q1 Qt 17

18 And will monopolist make super-profit in both markets? Depends where the ATC curve is, at output Qt eg A P1 B P2 MRa MC R F C Q2 Q1 Qt 18

19 Another way of looking at it: separate the two markets and the aggregate market The marginal revenue has to be the same in both markets r else the monopolist will move from the lower MR market to the higher MR market [remember the utility maximising behaviour of the consumer?] But the price he charges in each market depends on the demand in that market. And he will sell in both markets as long as his price is higher than his ATC = C P1 MRa MC P2 R C ATC Q2 Q1 Qt 19

20 So how has the monopolist benefited by price discrimination? If he had set price P1 for whole market, he would have had no sale at all from market 2. By separating the markets, he is able to get the full benefit of higher prices from market 1 As well as some extra profits from market 2 from which he would otherwise have got none. A P1 MC B P2 MRa P F Q2 Q1 Qt 20

21 Tutorial uestions: 1. xamine the mobile phone industry and outline how the monopolist is able to segment his market and charge different prices. 2. We have looked at the monopolist breaking his market into 2 separate markets. How could he make even more profit, and reduce consumer surplus even more? 3. What would be the logical end of the process in 3? First degree price discrimination 4. What do you think is the strategy followed by Fiji TV in their pricing of Sky Plus, Sky Pacific, and Pay TV? 21

Lecture 12. Monopoly

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