# More on monopoly Today Why singleprice profit maximization

• Slides: 47

More on monopoly Today: Why single-price profit maximization is typically inefficient; price discrimination

Today n Profit maximization of the monopolist n As usual, set MB = MC to maximize profit n n n Revenue is the benefit for the monopolist Remember that MB is decreasing for the monopolist Price discrimination and efficiency n n n Discounts Perfect price discrimination Rebates and coupons

Single-price profit maximization n n Remember that marginal revenue is below the price received by the monopolist (except for the first unit in a discrete case) See our continuous example we will use today

Single-price profit maximization n n We will find the point where MR and MC are equal Surplus and deadweight loss will then be calculated n MR has same vertical intercept as D, with twice the slope n Read Ch. 10 Appendix for algebraic approach to solving monopoly problems

Simple monopoly example n For this problem, note: n n n Linear downwardsloping demand curve Linear upwardsloping MC curve Remember: We maximize profit by setting MR = MC

Simple monopoly example n In an efficient market with many buyers and sellers, point I is the intersection of the supply (MC) and demand curves n Price is G, quantity is H

Simple monopoly example n As we will see with a monopoly, a different, less efficient outcome, occurs n n MR = MC at point K At quantity A, the monopolist can see from point E on the demand curve that price C can be charged

Simple monopoly example n Calculating surplus if this was an efficient market n Recall that triangle JI 0 is total surplus in an efficient market n n Triangle JIG for consumers Triangle GI 0 for suppliers

Simple monopoly example n n n At price C, consumer surplus falls to triangle JCE TR for monopolist is price C times quantity A Surplus for monopolist is trapezoid CEK 0

Simple monopoly example n What is lost? n n Triangle EIK is lost, since the monopolist stops producing once quantity reaches A This triangle is deadweight loss (DWL)

Why does DWL occur? n n n Marginal PUBLIC benefit comes from the demand curve Marginal PRIVATE benefit of the monopolist comes from the marginal benefit curve The socially optimal point comes from Marginal PUBLIC benefit n The monopolist ignores this when making its decisions

Price discrimination n Price discrimination can take many forms n n n 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 n Simple discount examples n Discounts at a movie theater n n n 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? n 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? n Price discrimination helps consumers and business n n n More consumers are able to enter the market Businesses are able to make more profits by segmenting markets Business charges price to maximize profit in each market

Discount example n n 10 people willing to pay a positive price to see “Bad Action Movie 4” 5 Non-students n n 5 Students n n Reservation prices of \$10, \$9, \$8, \$7, and \$5 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 n Price charged will be equal to the lowest reservation price of all people sold to in a market n n 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 5 th ticket, do not sell 6 th 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 Only one student buys a ticket NS 7 28 2 S 6 30 0 NS 5 30

What if we can segment the market between NS and S? n n 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 Remember: MC is \$1 per moviegoer 5

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

Ultimate price discrimination: Airlines n Airlines probably use price discrimination more than any other business n n n Tickets are non-transferable Discrimination based on date of purchase Discrimination between First-class, Business, and Economy seats

Airline price discrimination n n Prices of various routes out of Santa Barbara checked on different dates on United Airline’s website The lowest-cost flight was recorded n n 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 Barbara to Denver Date of 1/23 1/25 1/28 1/30 1/31 2/3 2/5 2/6 2/7 fare DEN 351 351 351 746 790 All fares in dollars n n Note that price generally goes up as time progresses People making late bookings often have higher willingness to pay for flights

Santa Barbara to… Date 1/23 1/25 1/28 1/30 1/31 2/3 2/5 of fare 2/6 2/7 JFK 600 730 360 730 1370 DEN 351 351 351 746 790 MSY 592 491 495 592 495 796 796 ORD 402 462 314 314 612 762 762 IAD 573 856 330 330 959 1061 All fares rounded to nearest dollar n Price sometimes changes more than once a week

What happened 1/30 to 2/1? Date 1/23 1/25 1/28 1/30 1/31 2/3 2/5 of fare JFK 600 730 DEN 351 351 MSY 592 491 ORD 402 462 IAD 573 856 730 351 495 314 330 360 351 592 314 330 360 351 495 314 330 2/6 730 1370 746 790 796 796 612 762 762 959 1061 All fares rounded to nearest dollar n 2/7 Price significantly drops in some flights

From United’s website: A sale from 1/29 to 2/1 n n 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) n n 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 n These sales usually have many limitations n Notice that one market examined did not have any discounts during the sale n n DEN Other restrictions often apply n n 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… n n 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 n n 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 n n Leaving Saturday 2/9 Returning Monday 2/11

More price discrimination: Last-minute fares (SBA/JFK) n From lastminute. com n n On United’s website, they advertise weekly efares for leaving on Saturday and returning on Monday or Tuesday n n American Airlines flight, \$321 \$326 fare Similar United flight two weeks later costs \$575 n Maybe check later to try for a better fare

Why does one day make a difference? n n 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? n Leisure travelers want to minimize the amount of work missed n n n 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 n n Low demand for business travelers Low demand for leisure travelers

Why does one day make a difference? n n Airlines know times of low demand They price discriminate in order to fill up planes, without losing revenue from other customers n These offers often have many limitations n United’s e-fares: You must typically leave Saturday and return two or three days later

More price discrimination n n Spirit Airlines often has sale prices below \$50 for one-way tickets However, restrictions are typically extreme n Example: You must fly each way on a Tuesday to get the sale fare

What if you were flexible? n On 1/31, 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) n Even with taxes and fees, the total roundtrip fare is \$104. 80

What if you were flexible? n Another example on Spirit Airlines, Orlando to Fort Lauderdale (same dates), \$19 each way n n \$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? n Airlines do not perfectly price discriminate, but they are able to make many more flights profitable by these pricing practices n n 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 n n Companies often use another method to price discriminate Customers are forced to seek a discount if they want to receive it n n Rebates: Force the customer to send in a form to receive discount Coupon: Make consumer find a coupon before purchase to get a discount

Example of hurdle n n Baseball teams often have lower attendance in mid-week games against bad teams A baseball team may coordinate with a sponsor n 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 n n Price can be controlled by the monopolist Various ways can be used to obtain market power n n Exclusive control over important inputs; Patents and copyrights; Government licenses or franchises; Economies of scale; Networks Downward-sloping MR curve n MR slope is twice that of D curve for linear demand curves

Summary of monopoly, part 2 n n n 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 n n We have now studied markets with one seller and many sellers We have yet to study other markets n Product-differentiated markets n n Markets with close substitutes (Example: Different brands of frosted-flake cereal) Markets with a few sellers

Product-differentiated markets n An owner of a popular brand of cereal has some market power over selling its good n n Firm can copyright the brand of cereal, a form of market power Demand may be flatly-sloped, due to the substitutes available n Small increase in price may substantially lower market share