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StiglerPriceDiscrimination - 210 THE THEORY OF MONOPOLY...

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Unformatted text preview: 210 THE THEORY OF MONOPOLY dominant and there is more room for the policy of moderate pricing to discourage entry”. 1 George SfIJier‘J. fie fiforq ‘0': Pride #tt'Ed. Varieties of Monopo y Pricing Discrimination We tentatively defined price discrimination as the sale of the same commodity at two or more prices. On this strict definition, price dis- crimination is a relatively uncommon phenomenon. The essence of discrimination is to separate buyers into two or more classes whose elasticities of demand difl‘er appreciably, and this usually requires that the product sold to the various classes ditfer in time, place, or appearance to keep all buyers from shifting to the market with the lower price. The purest cases Of discrimination are found where the commodity is intrin- sically untransferable (a service, like medical care) or can be prevented from being transferred by contract (as when buyers of aluminum for cable contracted not to use it for other purposeS). The scope of the theory may be enlarged by defining discrimination as the sale of two or more similar goods at prices that are in different ratios to marginal cost. If a book in hard cover sells for $15 and in a paperback Version for $5, there is presumably discrimination, since the binding costs are not sufficient to explain the difierence in prices.13 Price differences do not necessarily indicate discrimination. Banks charge small borrowers a higher interest rate than large borrowers of equal financial reliability because the costs of the small loan are larger per dollar ‘of loan. Wholesalers get lower prices than retailers if on the average the wholesalers buy in larger lots, pay more promptly, and so on. Conversely, price equality does not demonstrate the absence of dis- crimination. If a college charges the same tuition for a large elementary class taught by an instructor and a small advanced class taught by an expensive professor, it is clearly discriminating. However, if it charges the same tuition for two classes whose costs per student differ by say $5, we should not call it discrimination because it would undoubtedly cost more than $5 to have separate fees for the two classes. 12 See mathematical note 15 in Appendix B. 13 Our definition of discrimination turns upon the inequality, ' P1 P2 aé . M61 .MCZ Some economists prefer the slightly different definition: prices are discriminatory if the difference in price is not equal to the difference in marginal cost, or ' pl—MClaépz—MCZ. The proportionality definition has the merit of separating a monopolist’s behavior into two parts: (1) the simple restriction of output such that price is greater than marginal cost; and (2) the misallocation of the two or more goods among buyers when they are charged different prices, which is zero if prices are proportional to marginal costs. Varieties of Monopoly Pricing 211 Conditions for Discrimination The basic requirements for price discrimination are that there are two or more identifiable classes of buyers whose elasticities of demand for the product differ appreciably and that they can be separated at a reasonable cost. The demands of different buyers will be governed by the factors discussed in Chapter 3. Their elasticities may vary with 1. Income, as in the demand for medical care. . 2. Availability of substitutes, as in the use of aluminum for cans facrng strong competition from tin plate and glass, whereas alurrnnum in aircraft does not have good substitutes. 3. As a special case of substitutes, there may be rivals in one market (say, foreign) but not in the other (domestlc). 4. Urgency of tastes, as when some buyers are eager to get early access to the commodity (a first-run movie). The form of discrimination is often more subtle than these examples might suggest. It has been common, for example, to lease rather than sell certain kinds of machinery, although the practice has declined due to antitrust prosecutions. When shoe machinery was leased, the basic charge was so many cents per pair of shoes processedwfor example, 0.5 cents per pair for heel loading and attaching.14 If use is not the chief cause of a machine’s retirement, and it has more often been obsolescence, costs clearly are not twice as high for a machine that produces twice as many shoes, so discrimination is being practiced. The use of output as a basrs for pricing is then a simple method of measuring the urgencies of desire of different manufacturers for the machine. The tie-in sale may ofi‘er a still more indirect method of dis- criminating among customers. If the use of a machine is correlated with some other commodity—salt tablets for a dispensing machine, cards for a tabulating machine—the machine may be leased on a time bas1s and the user compelled to buy the related material from the lessor, who uses this material as a metering device to measure urgency of demand. For this explanation to hold, of course, the metering device must be sold at more than a competitive price. Discriminatory Pricing The monopolist will fail to maximize the receipts from the sale of a given quantity of his product unless the marginal revenue in each separable market is equal. For example, suppose he sells a given aggregate quantlty 1“ See Carl Kaysen, United States v. United States Shoe Machinery Company, Cambridge, Mass: Harvard University Press, 1956, p. 322. 212 THE THEORY OF MONOPOLY Figure 12-5 in twomarkets at $10. If the demand elasticities are ‘—2 and —3, the respectlve marginal revenues are $5 and $6.67, and the transfer of a unit from the former to the latter market will raise receipts by $1.67. In addition, the common marginal revenue must equal marginal cost. The determination of prices may be illustrated graphically (Figure 12-5). Let the demand curves in two separable markets be D1 and ‘D2, w1th corresponding marginal revenues MR1 and MR2. Then if the marglnal revenue curves are added horizontally to get MR,, we obtain the curve of aggregate quantities that can be sold at given marginal revenues. Output will be set where total marginal revenue equals margin- al cost, or- DC. This output will be sold in the two markets at prices P1 and P2, for at these prices marginal revenues are equal. This analysis holds only if the markets are independent—that is, if the demand curve in one market does not depend upon the price set in the other market. This is seldom the case. Often there is some direct movement of consumers between markets: if first-run movies get more expenswe relative to second runs, some people will shift from the former to the latter. Often the movement is indirect. For example, if a railroad . Varieties of Monopoly Pricing 213 has no competitiOn at point A but other transportation rivals at point B, we should expect demand for railroad transportation to be less elastic at the former point. Yet if the firms at A and B are in the same industry and selling in the same markets, in the long run the branch of the industry at A will decline if high rates are charged. The theory of discrimination is only a special case of the theory of monopolies selling multiple products, and when the markets are not independent it is then necessary to treat the products sold in the various markets as fair substitutes, for one another and employ the theory of multiple products. That theory says simply that the monopolist will maximize profits if he equates the marginal revenue and marginal cost of each product. If the products are related in demand, however, one must calculate a “corrected” marginal revenue that takes account of the effect of the price of one product on the sales of others. For example, if product A has the demand schedule: Price Quantity Receipts $10 100 $1,000 9 200 1 ,800 the crude marginal revenue is $800 / 100 = $8. But if this reduction in the price of A decreases the sales of a substitute product B, also sold by the monopolist, from 500 to 400 units at a unit profit of $3, then the net gain of receipts is only $500 and the marginal revenue from selling 200 units of A is only $5. , Discrimination as (1 Condition for Existence Although discriminatory prices are an ineflicient method of allocating a commodity among individuals, they do yield a larger revenue than a single price system. Situations may therefore exist in which costs of production cannot be covered by receipts unless discrimination is prac- ticed. Consider, for example, a community with two classes of consumers, with the respective demand curves for a commodity, D1 and D2 (Figure 12-6). Adding these demand curves, the total demand curve is RST. The average cost of producing the cominodity is C. Without discrimination, there is no output at which price is so large as average cost. With discrimination, a quantity A1 can be sold at price P1, another quantity A2 at price P2, and the total quantity (A1 + A2 = A3) sells for an average price of P3, which exceeds its cost. This is, in a simplified form, the defense of price discrimination among commodities by railroads. In less ...
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