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Outline
• Pricing and Elasticities
Pricing and Price Discrimination • Price Discrimination
• The Coase Conjecture
K. Graddy
Industrial Organization
i qi P (Q ) C i ( qi ), Q q1 q 2 .... q n
Monopoly
i P (Q ) Q
R -C P (Q ) qi C '( qi ) 0
qi Q qi
FOC : MR - MC 0 P Q
P- qi C '( qi )
P ( q )q - C ( q ) Q qi
Q
P(q) In Cournot competition, 1.
FOC : P(q) q * C '(q) qi
q Q P
Furthermore, multiplying through by ( 1)
P(q) P(q) P Q
P( q ) q * * C '(q) P Q P
q P(q) P- qi C '( qi )
Q P Q
P( q)
P( q ) - C '(q) 1 q
P P i C '( qi )
Q
P C '(q) 1 P C '( qi ) si
(Inverse elasticity rule) p
P
The Lerner Index Estimating Elasticities
• So, the Lerner Index (the price cost mark‐up) • Statistical
in an oligopoly is just the market share of firm ln Pt o 1 ln Qt 2 Day1 3 Day 2 4 Day 3 5 Day 4 t
i divided by the elasticity. or
ln P1t o 1 ln Q1t 2 P2t 3 P3t 4 P4t 5 Loc t
Need an "instrument" to control for endogeneity
Pt
ln Pt P 1
d( ) t
ln Qt Qt
Qt
• Surveys
• Qualitative
1
10/9/2009
Qualitative Determinants of Elasticity
• Demand for a product is more elastic, the • Price Discrimination Depends on Elasticities
– more like a luxury good and less like a necessity it
is
– larger share of budget assigned to it
larger share of budget assigned to it
– the more substitutes to it that exist
– in long run than in short run
– the better the consumer information
How much is a product worth to a
Price Discrimination consumer?
• Occurs when different net prices are charged for • Reservation price: How much a consumer is
the same good
willing to pay rather than do without the good
– Suppose consumers differ in their distance from the
point of sale: If differences in prices exactly reflect • Consumer surplus: Difference between what a
transport costs prices are not discriminatory
transport costs, prices are not discriminatory consumer is willing to pay for a good and what
consumer is willing to pay for a good and what
– Suppose consumers buy nearly identical variants of the he actually pays
same basic good. If the difference in price between
variants exactly equals the cost of characteristics that – The consumer surplus is measured by the area
are in one but not the other, prices are not under the demand curve above the market price
discriminatory
First Degree Price Discrimination
price
consumer surplus • Every consumer pays his own reservation
price
R=P
(marginal buyer) • Marginal Revenue = Average Revenue
market price – Most profitable type of pricing
M t fit bl t f i i
P
– Same quantity is sold as in competition
• Possible examples: small town doctor, shoe
R>P
(in market)
R<P
(out of market)
D repair shop, piano teacher
quantity
2
10/9/2009
Second Degree Price Discrimination
• Consumers distinguished by the quantity of
the good they consume Surplus of single
price monopolist
– Quantity discounts
PM Gain from 2nd
Gain from 2nd
– Two‐part tariffs
Two part tariffs degree price disc.
• Examples: software site licenses, toothpaste P2
MC
QM Q2
Third Degree Price Discrimination
Formally, for each market set
• Consumers are divided into groups or market
segments according to some observable
MC=MR1 MR2
characteristic, and each is charged a different Since for market i:
price
– Higher price is given to buyers with less elastic 1
demand MR i pi (1 )
• Examples: airlines, student and senior i
discounts
Coase model of a durable monopoly
Assumptions of Model
good (CP, p. 522)
– Assume a seller cannot sign contracts limiting his future • Lifetime of good exceeds the basic “period”
production.
• Upon sale of a unit, optimal strategy is to try to sell another unit at – Period is the length of time between price
as high a price as he can get revisions
• This would go on until price equals marginal cost
– Goods offered by monopolist at two different
Goods offered by monopolist at two different
– Suppose very little time is needed to transact dates are substitutes
• Intelligent consumers, assuming the price will soon fall to the
competitive level, will be unwilling to pay more than the – Customers have “rational” expectations
competitive price for the early units.
• This could go on until price equals marginal cost; monopolist can
lose all control of situation.
3
10/9/2009
• First
Example – Assume monopolist makes once and for all offer in the
first period of the monopoly price, which is 4. He sells
• 7 customers to consumers with valuations 4 to 7
– Monopoly profit is 4*4=16
• Valuations v=1,2,…,7
• At beginning of period 2, have residual demand of
• Each consumer derives utility from 1 unit of consumers with valuations 1 through 3.
the good
the good Monopolist is then tempted to charge a lower
Monopolist is then tempted to charge a lower
• Time is discrete t=1,2,… and discount factor δ price.
– Some consumers with high valuations may still accept
between periods paying 4 because they are eager to get the good
• No cost to produce the good and the good is – However, likely that consumer with valuation 4 does
infinitely durable not buy, because his surplus is zero
– Necessary condition to purchase: v‐4≥δ(v‐2)
• Equilibrium: Responses
– A sequence of prices and consumers’
expectations such that the expectations are • An artist may make a lithograph and destroy the
rational given the firm’s behaviour and such plate
that the firm’s behaviour is optimal given the • A seller rents rather than sells
consumers’ expectations – IBM
– Xerox
X
– Monopolist price discriminates over time • Crucial difference between seller and renter is that if a renter
• Books “overproduces” he suffers capital loss on old units, the costs are
internalised; rational for him to limit production
• Computers
• For a seller, buyer suffers cost; sellers end up overproducing
• Flexibility hurts the monopolist • Firms that rent can resemble monopolists producing nondurable
goods
• Find ways of capacity commitment (spend too
little on fixed costs and too much on marginal Conclusion
cost)
• Give price guarantees (a money‐back guarantee • Why firms are interested in elasticities
exercisable at any time)– makes it very expensive
for firms to lower price to new consumers • Price discrimination
• Transfer monopoly power to service contracts or – Pervasive
in another area
in another area – Can be extremely “unfair”
C b l “ f i”
– Car servicing
– Polaroid in film
• A durable goods monopolist
– Gillette in blades
• Implicit contracts not to lower price – DeBeers
never reduced nominal price of diamonds.