7 Monopoly Practices

7 Monopoly Practices - Monopoly Practices and Price...

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Monopoly Practices and Price Discrimination
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Perfect Price Discrimination All price discrimination schemes share an underlying strategy to segment the market and to charge each segment a different price relative to its cost. Perfect Price Discrimination occurs when the monopolist can successfully extract the maximum possible profit from each customer and therefore the whole market.
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The monopolist knows exactly what each customer’s reservation price is (the most the customer is willing to pay). He charges each customer a price exactly equal to their reservation price. There is no consumer surplus because every customer pays exactly their willingness-to-pay price. This is hard to do in practice. A close example is an accountant who charges each client a different price.
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Ordinary Price Discrimination More commonly, a monopolist is able to segment the market and allocate output and charge prices that will maximize the firm’s profit. A firm could segment by region, age, gender etc. The monopolist would have to know the demand (and hence, MR) in each market segment. A profit maximizing monopolist engaging in ordinary price discrimination will choose an aggregate output where (aggregate)MR=MC. Output is allocated so MR is the same in all market segments. Here’s the proof:
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For given supply levels y 1 and y 2 the firm’s profit is The profit-maximization conditions are Π ( , ) ( ) ( ) ( ). y y p y y p y y c y y 1 2 1 1 1 2 2 2 1 2 = + - + ( 29 Π y y p y y c y y y y y y y 1 1 1 1 1 1 2 1 2 1 2 1 0 = - + + × + = ( ) ( ) ( ) ( ) ( 29 Π y y p y y c y y y y y y y 2 2 2 2 2 1 2 1 2 1 2 2 0 = - + + × + = ( ) ( ) ( ) ( )
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and so The profit-maximizing conditions are (MR 1 ) (MC) (MR 2 ) (MC) ( ) y y y 1 2 1 1 + = ( ) y y y 1 2 2 1 + = ( 29 y p y y c y y y y 1 1 1 1 1 2 1 2 ( ) ( ) ( ) = + + ( 29 y p y y c y y y y 2 2 2 2 1 2 1 2 ( ) ( ) ( ) . = + +
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In other words,
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Numerical Example
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p b = 36 – ½(30) = 21
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Note that if you left numbers as decimals instead of converting to fractions, you would have found that profit equals $1934.58. On a test, don’t bother to convert to fractions.
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Note that the price is higher in the market where demand is more inelastic . Recall: MR(y) = P [1 – 1/|E|] Since the monopolist equates the MR across the different markets MR (y 1 ) = MR (y 2 )
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p 1 [1 – 1/|E|] = p 2 [1 – 1/|E|] If the elasticities were equal then, p 1 = p 2 Suppose the elasticity of demand in market 2 was less elastic (more inelastic) than in market 1.
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Then |E| in market 2 < |E| in market 1 1/|E| > 1/|E| [1 – 1/|E|] < [1 – 1/|E|] In order to preserve the equality p 1 [1 – 1/|E|] = p 2 [1 – 1/|E|] p 2 must be greater than p 1 Therefore, price is higher in the market where demand is more inelastic
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Criteria for Price Discrimination First, the monopolist must be able to identify different price elasticities of demand and segment the market accordingly.
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This note was uploaded on 06/18/2011 for the course ECON 2X03 taught by Professor Jamesbruce during the Fall '10 term at McMaster University.

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7 Monopoly Practices - Monopoly Practices and Price...

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