Chapter 14: Price Discrimination and Public Strategy Price discrimination: selling the same product at different prices to different customers. 1) If the demand curves are different, it is more profitable to set different prices in different markets than a single price that covers all markets. 2) To maximize profit, the firm should set a higher price in markets with more inelastic demand. 3) Arbitrage (buying low in one market and selling high in another market) makes it difficult for a firm to set different prices in different markets, thereby reducing the profit from price discrimination. To succeed at price discrimination, monopolist must prevent arbitrage. Example of PD: Firms offer different versions of a product for the purpose of segmenting customers into different markets. Perfect price discrimination : each customer is charged their maximum willingness to pay. Consumers end up with zero consumer surplus and all of the gains from trade goes to the monopolist. Since the PPD monopolist gets all the gains from trade, the PPD monopolist has an incentive to maximize the gains from trade, which means no deadweight loss. A PPD monopolist produces the efficient quantity until MR=MC. Price discrimination is bad if the total output with PD falls or stays the same, but if output increases under price discrimination, then total surplus will usually increase. Tying : occurs when to use one good, the consumer must use a second good that is sold only by the same firm. A firm can price-discriminate by tying two goods and carefully setting their prices. Bundling : is requiring that products be bought together in a bundle or package. It can increase efficiency especially when fixed costs are high and marginal costs are low. Bundling means that fixed costs are spread across more consumers, which raise the incentive to innovate. Firms want to price-discriminate because PD increases profits and may also increase total surplus. PD is most likely to increase total surplus when it increases output and when there are large fixed costs of development. PD for pharmaceuticals lowers the price for consumers in poor countries and by increasing profits, PD increases the incentive to research and develop new drugs. Less elastic demand = higher price and more elastic demand = lower price (elasticity = escape) Chapter 15: Oligopoly and Game Theory Cartel is a group of suppliers who try to act as if they were a monopoly. Tend to collapse due to cheating by members, new entrants and demand response, and government prosecution and regulation. The incentive to cheat: When a monopolist increases quantity beyond the profit-maximizing quantity, the monopolist hurts itself. But, when a cartel cheater increases quantity beyond the profit-maximizing quantity, the cheater benefits itself and hurts other cartel members (Figure 15.3). When a monopolist lowers the price and increases its sales, it enjoys all of the gains from selling more (green area left panel), but it bears all the losses from selling its previous output at a lower price (red area). If a four-
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