Review Exercise (1)

1. Review Exercise (1) • #3, p.344 PRGE • True or False? A profit maximizaing monopoly faces a demand with constant price elasticity of -2. His marginal cost is also constant at 20$. If his marginal cost rises by 25%, the price he charges will also rise by 25%.

2. Review Exercise (1) • #3, p.344 PRGE • PM0 = MC0/(1+1/ED) = 20$/(1-1/2) = 40$ • MC1 = (1+0.25)* MC0 = 25$ • PM1 = MC1/(1+1/ED) = 25$/(1-1/2) = 50$ • ∆% PM ?= (PM1- PM0)/ PM0 = (50$-40$)/40$=... • 10$/40$=25% • MC ∆ ↑25%  PM ∆ ↑25% • TRUE

3. Review Exercise (2) • True or False? A monopoly nerver produces in the inelastic part of the demand curve.

4. Review Exercise (2) • True or False? A monopoly nerver produces in the inelastic part of the demand curve. • In the inelastic part of the demand curve, by raising the price the monopoly generates higher revenues because the corresponding fall in the quantity demanded is proportionally smaller. Furthermore, the drop in quantity implies a fall in costs. • ↑ revenus & ↓ coûts = ↑profits. • The producer would never maintain a level of production in the inelastic part of the demand curve. TRUE

5. Review Exercise (3) #18 a) et b) p.346 PRGE Profit maximizing monopoly; Q = 144 / P2 CF=5 CVM=Q1/2 a) PM? QM? ProfitsM? b) What happens if the government imposes a price ceiling of 4$?

6. Review Exercise (3) a) MR? D: Q=144/P2→ P2=144/Q → P=12/Q1/2 Rev = P*Q = (12/Q1/2)*Q = 12 Q1/2, MR = dRev / dQ = 6/Q1/2 MC? = dCT / dQ = dVC / dQ VC? AVC=VC/Q  VC=AVC*Q VC= Q1/2*Q = Q3/2 MC = dQ3/2 / dQ = 3/2*Q1/2

7. Review Exercise (3) a) MR = MC 6/Q1/2 = 3/2*Q1/2 , 6 = 3/2*Q 12/3 = QM = 4 PM? D(QM)=12/(QM)1/2 = 12/2 = 6 = PM Profits? (PM*QM) – C(QM) (6$*4) – (43/2$ + 5$) 24$ - 13$ = 11$ = πM

8. Review Exercise (3) b) The State fixes a price ceiling at 4$. D: Q = 144/P2 = 144/16 = 9 = QGOUV Profits = (4$*9) – (93/2 + 5$) = 36$ - 27$ - 5$ = 4$

9. MC MR AC PM PGOUV QGOUV QM

10. Pricing strategies

11. Introduction • Why do student discounts exist? • Why is a firm like Costco profitable? • Why is it that your neighbor on the plane likely has not paid the same price as you for his plane ticket?

12. Example: nightclub Population: • 100 men, each willing to pay 10$ • 100 women, each willing to pay 5$ What should the club’s cover charge be? (MC = 0) • If p = 10$, who will buy? π = ? • If p = 5$, same questions. How can the club do better?

13. A possible solution Price discrimination (PD) : Charge different people different prices for the same product. Nightclub example: • charge 5$ for women • charge 10$ for men  π = __________

14. Who can practice PD? 3 necessary conditions, on: • the ability to choose your selling price • the information about potential customers • the customers’ ability to resell the product Explain in detail.

15. Perfect PD (1st degree) Def: Charge each consumer his willingness to pay p Ex: Cupcake stand MC ≡ $1.50 apiece (constant) Who will buy a cupcake? How much will each person pay? What will profits be? Ali 4 Ben 3 Cat MC 2 Dave 1 D Q 1 2 3 4

16. Perfect price discrimination (cont.) More generally, for a larger population. p Ex: D : p = 40 - Q S : MC = Q How many units will be sold? Compute CS, PS and W. Compare with: - Competition - Traditional Monopoly 40 S D Q 40

17. Perfect price discrimination (end) Interpretations : • Is perfect PD efficient? • Is it fair? • Is it realistic? Give examples of markets approaching perfect price discrimination.

18. Explicit market segmentation(3rd degree PD) Def.: Consumers can be differentiated according to an observable characteristic Examples : • _________________________________ • _________________________________ • _________________________________ • ….

19. Explicit market segmentation (cont.) Example : Levi’s 501 jeans in Europe (E) and in North America. ( MC ≡ $5 apiece ) p p 45 DE 35 DNA MC 5 5 QNA QE 7000 4500

20. Explicit market segmentation (end) What will the price be on each continent? Give an interpretation in terms of price-elasticity?

21. Implicit market segmentation(2nd degree PD) Def.: Consumers are discriminated according to an unobservable characteristic: their own preferences  Price menus, block pricing Examples : • _________________________________ • _________________________________ • _________________________________ • ….

22. Implicit market segmentation (cont.) Example: Cell-phone plan (MC ≡ 10 ¢/mn) • Plan 1: 200 mn for 40 $/month • Plan 2: 400 mn for 70 $/month • Plan 3: 600 mn for 90 $/month • Two types of consumers: • Type 1: q1 = 650 - 20p • Type 2: q2 = 550 - 20p • Which plan will each type of consumer choose?

23. Type 1 Consumers Chooses plan 2 b/c C > D CS: A+B+C-D PS: E+H+F+G+I+J

24. Type 2 Consumers Chooses plan 1 b/c G > H CS: A-B PS: C+D+B+E+F

25. Monopoly pricing (no discr.)

26. Implicit market segmentation (cont.) What pricing schedule does this plan menu correspond to? In other words, what is the per-minute price of the first 200mn? What is the per-minute price of the next 200mn? (from 200 to 400) What is the per-minute price for the last 200mn? (from 400 to 600) p Draw the price « line » 20 15 10 Q 200 400 600

27. Implicit market segmentation (cont.) p Type 1 consumer: d1 : q1 = 650 – 20p Which plan will she choose? Why? Show CS1 and PS1 graphically. 30 d1 25 20 15 MC 10 Q 200 400 600

28. Implicit market segmentation (cont.) p Type 2 consumer: d2 : q2 = 550 – 20p Which plan will she choose? Why? Show CS2 and PS2 graphically. 30 d2 25 20 15 MC 10 Q 200 400 600

29. *Implicit market segmentation (end) Exercise: Consider a population of 100 consumers of each type Compute the consumer surplus, producer surplus and total welfare for this entire population Compare with the traditional monopoly. [Hint: First draw the demand curve of the entire population]

30. Conclusions • Several types of price discrimination: • perfect (or 1st degree) • explicit segmentation (or 3rd degree PD) • implicit segmentation (or 2nd degree PD) • Price discrimination is everywhere! Look for more examples around you. • Next: Competition and strategic interactions