More on monopoly

Today: More on monopoly and efficiency; price discrimination

Last lecture

Introduction to monopoly MR < P How a firm can gain market power Monopolies that must charge the

same price to all customers

Before we start…

Is discrimination legal? Yes, but not all kinds Some kinds of discrimination that are

legal Student status Age (sometimes) Recent college graduate Timing of purchase

More on this later

Today Controlling of monopolies More on monopolist profit maximization

As usual, set MB = MC to maximize profit Revenue is the benefit for the monopolist Remember that MB is decreasing for the monopolist

Price discrimination and efficiency Discounts Perfect price discrimination Rebates and coupons

Recall: Single-price profit maximization Remember that

marginal revenue is below the price received by the monopolist (except for the first unit in a discrete case)

Recall our continuous example from Wednesday

Maximize profit by setting MR = MC

Simple monopoly example Efficient outcome

Green circle Quantity H Price G

Monopoly outcome Point K, MR = MC Quantity A Price C

Simple monopoly example Calculating

surplus if this was an efficient market

Recall that triangle JI0 is total surplus in an efficient market

Triangle JIG for consumers

Triangle GI0 for suppliers

Simple monopoly example

What is DWL? Triangle EIK

is lost, since the monopolist stops producing once quantity reaches A

Why does DWL occur? Marginal PUBLIC benefit (i.e. total benefit

of supplier and demanders) comes from the demand and supply curves

Marginal PRIVATE benefit of the monopolist comes from the marginal benefit and supply curves

The socially optimal point comes from Marginal PUBLIC benefit The monopolist ignores this when making its

decisions

Monopoly inefficiency

As we have seen, monopolies typically produce quantities that are less than efficient

This leads to positive economic profits

Controlling monopolies

Laws have been passed to control monopoly profits

Regulation typically tries to set economic profit to be about zero This sometimes makes regulated

stocks a relatively safe investment

Price discrimination Price discrimination can take many

forms Discounts of goods and services that have

little or no value if transferred to another person

Perfect price discrimination, where a different price can be charged to each person

Rebates, which require effort to get a discount

Discounts in some businesses with at least some market power

Simple discount examples Discounts at a movie theater

Seniors Students Matinees and “twilight” showings

5% senior discount at a store on Tuesdays

Super $5 Monday (Expos/Padres)

Why are these types of discounts offered?

All of these discounts are applied because demand at a given business depends on the day of the week, the time of day, and/or the average income of a group of people

Why are these types of discounts offered?

Price discrimination helps businesses and low-value consumers More consumers are able to enter the

market Businesses are able to make more

profits by segmenting markets Each business charges price to

maximize profit by buyer type

Discount example 10 people willing to pay a positive price

to see “Bad Action Movie 4” 5 Non-students

Reservation prices of $10, $9, $8, $7, and $5 5 Students

Reservation prices of $6, $4, $3.25, $2.50, and $1

Assume $1 in VC per moviegoer Sell another ticket if MR ≥ $1

Assumption in the following analysis

Price charged will be equal to the lowest reservation price of all people sold to in a market Any higher price will lower sales Any slightly lower price will decrease

revenue without changing costs

What if there are no discounts?

Type of person Reservation price ($)

Total rev. ($) MR ($)

10

NS 10 10

8

NS 9 18

6

NS 8 24

4

NS 7 28

2

S 6 30

0

NS 5 30

Sell 5th ticket, do not sell 6th ticket; Price is $6

Type of person Reservation price ($)

Total rev. ($) MR ($)

10

NS 10 10

8

NS 9 18

6

NS 8 24

4

NS 7 28

2

S 6 30

0

NS 5 30

Only one student buys a ticket

What if we can segment the market between NS and S?

We can continue to sell to the same non-students while increasing sales to students

We will now look at each market separately

Still sell to 4 NS, but price goes up to $7 to maximize profit

Type of person

Res. price ($) Total rev. ($) MR ($)

10

NS 10 10

8

NS 9 18

6

NS 8 24

4

NS 7 28

–3

NS 5 25

Sell to 3 students, at a price of $3.25 each

Type of person

Res. price ($) Total rev. ($) MR ($)

6

S 6 6

2

S 4 8

1.75

S 3.25 9.75

0.25

S 2.50 10

-5

S 1 5Remember: MC is $1 per moviegoer

Additional profits

Left to student: Calculate profit both with and without price discrimination You should find that profit is higher

with price discrimination

Ultimate price discrimination: Airlines

Airlines probably use price discrimination more than any other business Tickets are non-transferable Discrimination based on date of

purchase Discrimination between First-class,

Business, and Economy seats

Airline price discrimination Prices of various routes out of Santa

Barbara checked on different dates on United Airline’s website

The lowest-cost flight was recorded Some interesting ways to get between Santa

Barbara and another city at lowest cost (Example: Santa Barbara to Los Angeles to Aspen to Denver)

All dates are 2008, for flights departing Santa Barbara 2/8, and returning 2/10

Santa Barbarato Denver

Note that price generally goes up as time progresses

People making late bookings often have higher willingness to pay for flights

Date of

fare

1/23 1/25 1/28 1/30 1/31 2/1 2/3 2/5 2/6 2/7

DEN 351 351 351 351 351 351

746

746

790

790

All fares in dollars

Santa Barbara to…

Price sometimes changes more than once a week

Date of

fare

1/23 1/25 1/28 1/30 1/31 2/1 2/3 2/5 2/6 2/7

JFK 600 600 730 730 360 360

730

730

1370

1370

DEN 351 351 351 351 351 351

746

746

790 790

MSY 592 592 491 495 592 495

796

796

796 796

ORD 402 402 462 314 314 314

612

762

762 762

IAD 573 573 856 330 330 330

959

959

1061

1061

All fares rounded to nearest dollar

What happened 1/30 to 2/1?

Price significantly drops in some flights

Date of

fare

1/23 1/25 1/28 1/30 1/31 2/1 2/3 2/5 2/6 2/7

JFK 600 600 730 730 360 360

730

730

1370

1370

DEN 351 351 351 351 351 351

746

746

790 790

MSY 592 592 491 495 592 495

796

796

796 796

ORD 402 402 462 314 314 314

612

762

762 762

IAD 573 573 856 330 330 330

959

959

1061

1061

All fares rounded to nearest dollar

From United’s website: A sale from 1/29 to 2/1 4 Day U.S. sale Airfare to dozens of U.S. cities--now on

sale through Friday

For a special 4 day period, United is dropping fares to and from many of the country's most visited and exciting destinations. Fly to or from Denver, San Francisco, Los Angeles, Washington-Dulles, and more during the month of February and save with these low rates.  Remember though, book on united.com by this Friday, to take advantage!

Another sale held at the same time (also from United’s website)

Chicago 4 day sale Windy city deals are in the air

The Magnificent Mile, Millenium Park, and, of course, the deep dish pizza, are all staples of Chicago. Read more about Chicago.  And between now and this Friday, United has put travel to and from Chicago on sale.  Just remember to book on united.com, where you'll never pay a booking fee.

One other thing to note These sales usually have many

limitations Notice that one market examined did

not have any discounts during the sale DEN

Other restrictions often apply 4-day US Sale: Stay must be 1-30 days;

travel only allowed through the end of February

Chicago Sale: Complete travel by March 10

If you ignore the sale…

Notice that price generally increases as time progresses

This corresponds to people with a high willingness to pay more often buy their tickets close to the departure date

More price discrimination: Last-minute fares

For flights that are not expected to fill up, some airlines will lower the fare if you are willing to buy no more than a few days before the flight leaves

We will look at fares for SBA to JFK Leaving Saturday 2/9/08 Returning Monday 2/11/08

More price discrimination: Last-minute fares (SBA/JFK) From lastminute.com

American Airlines flight, $321 On United’s website, they advertise

weekly e-fares for leaving on Saturday and returning on Monday or Tuesday $326 fare

Similar United flight two weeks later costs $575 Maybe check later to try for a better fare

Why does one day make a difference?

We see that a last-minute fare can be much lower if you leave Saturday and return Monday (relative to Friday and Sunday, respectively)

Why do airlines offer these deals?

Why does one day make a difference? Leisure travelers want to minimize the

amount of work missed They often try to leave Friday for weekend

getaways They want to return on Sunday

Saturday is often a good day to fly from the flexible traveler’s viewpoint Low demand for business travelers Low demand for leisure travelers

Why does one day make a difference?

Airlines know times of low demand They price discriminate in order to

fill up planes, without losing revenue from other customers These offers often have many

limitations United’s e-fares: You must typically

leave Saturday and return two or three days later

More price discrimination

Spirit Airlines often has sale prices below $50 for one-way tickets

However, restrictions are typically extreme Example: You must fly each way on a

Tuesday to get the sale fare

What if you were flexible?

On 1/31/08, you could have booked a roundtrip from Fort Lauderdale to Nassau, Bahamas for $9 each way if your trip is from 2/12 – 2/26 (both Tuesdays) Even with taxes and fees, the total

round-trip fare is $104.80

What if you were flexible?

Another example on Spirit Airlines, Orlando to Fort Lauderdale (same dates), $19 each way $59 round-trip with taxes and fees Comparable in price to Greyhound’s

7-day advance purchase fare ($58) and Amtrak’s fare ($64)

Perfect price discrimination? Airlines do not perfectly price

discriminate, but they are able to make many more flights profitable by these pricing practices By price discriminating, airlines are able

to offer more flights to more places Perfect price discrimination would

involve being able to charge a price specific to each person

Hurdles: Rebates, coupons, and sales Companies often use another method to

price discriminate Customers are forced to seek a discount

if they want to receive it Rebates: Force the customer to send in a

form to receive discount Coupon: Make consumer find a coupon

before purchase to get a discount Sales: See slides about United’s sale, for

example

Example of hurdle Baseball teams often have lower

attendance in mid-week games against bad teams

A baseball team may coordinate with a sponsor Hypothetical example: “Visit the Duff

Bear display at your local supermarket to get your half-off coupon to select Isotope home games”

Summary of monopoly, part 1 Price can be controlled by the monopolist Various ways can be used to obtain

market power Exclusive control over important inputs;

Patents and copyrights; Government licenses or franchises; Economies of scale; Networks

Downward-sloping MR curve MR slope is twice that of D curve for linear

demand curves

Summary of monopoly, part 2 Unregulated monopolies will set MB =

MC to maximize profit, leading to DWL Monopolies are often controlled to

prevent substantial positive economic profits

Price discrimination and hurdles can reduce inefficiencies of a monopolistic market

Introducing other kinds of markets

We have now studied markets with one seller and many sellers

We have yet to study other markets Product-differentiated markets

Markets with close substitutes (Example: Different brands of frosted-flake cereal)

Markets with a few sellers

Product-differentiated markets An owner of a popular brand of

cereal has some market power over selling its good Firm can copyright the brand of

cereal, a form of market power Demand may be flatly-sloped, due

to the substitutes available Small increase in price may

substantially lower market share

Next topic

Thinking strategically This is important in markets with

only two firms