Pricing With Market Power

Chapter 11
Pricing with Market Power

Topics to be Discussed
 Capturing Consumer Surplus

 Price Discrimination
 Intertemporal Price Discrimination and
Peak-Load Pricing
 The Two-Part Tariff
 Bundling
 Advertising
©2005 Pearson Education, Inc. Chapter 11 2

Introduction
 Pricing without market power (perfect

competition) is determined by market
supply and demand
 The individual producer must be able to
forecast the market and then concentrate
on managing production (cost) to
maximize profits

Introduction
 Pricing with market power (imperfect

competition) requires the individual
producer to know much more about the
characteristics of demand as well as
manage production

Capturing Consumer Surplus
 All pricing strategies we will examine are
means of capturing consumer surplus
and transferring it to the producer
 Profit maximizing point of P* and Q*
But some consumers will pay more than P*
for a good
 Raising price will lose some consumers, leading
to smaller profits
 Lowering price will gain some consumers, but
lower profits

$/Q The firm would like to
charge higher price to
Pmax those consumers
A willing to pay it - A
P1 Firm would also like to
sell to those in area B but
P* B without lowering price to
all consumers
P2
MC Both ways will allow
the firm to capture
PC more consumer
surplus
D
Q* MR Quantity
 Price discrimination is the practice of
charging different prices to different
consumers for similar goods
Must be able to identify the different
consumers and get them to pay different
prices
 Other techniques that expand the range
of a firm’s market to get at more
consumer surplus
Tariffs and bundling

Price Discrimination
 First Degree Price Discrimination
 Charge a separate price to each customer: the
maximum or reservation price they are willing to pay
 How can a firm profit?
 The firm produces Q*  MR = MC
 We can see the firm’s variable profit – the firm’s profit
ignoring fixed costs
Area between MR and MC
 Consumer surplus area between demand and price

 If the firm can price discriminate perfectly,

each consumer is charged exactly what
they are willing to pay
MR curve is no longer part of output decision
Incremental revenue is exactly the price at
which each unit is sold – the demand curve
Additional profit from producing and selling
an incremental unit is now the difference
between demand and marginal cost

Perfect First-Degree Price
Discrimination
$/Q Without price discrimination,
output is Q* and price is P*. Consumer surplus is the area
Variable profit is the area above P* and between
Pmax 0 and Q* output.
between the MC & MR (yellow).
With perfect discrimination, firm

MC will choose to produce Q**
P* increasing variable profits to
include purple area.
PC
D = AR
MR
Q** Quantity
Q*
First-Degree Price Discrimination
 In practice, perfect price discrimination

is almost never possible
1. Impractical to charge every customer a
different price (unless very few customers)
2. Firms usually do not know reservation price
of each customer
 Firms can discriminate imperfectly
 Can charge a few different prices based on
some estimates of reservation prices

First-Degree Price Discrimination
 Examples of imperfect price

discrimination where the seller has the
ability to segregate the market to some
extent and charge different prices for the
same product:
Lawyers, doctors, accountants
Car salesperson (15% profit margin)
Colleges and universities (differences in
financial aid)

First-Degree Price
Discrimination in Practice
$/Q Six prices exist resulting
in higher profits. With a single price
P*4, there are fewer consumers.
P1
P2 Discriminating up to
P3 P6 (competitive price)
MC will increase profits.
P*4
P5
P6
MR
Q* Quantity

Second-Degree Price
Discrimination
 In some markets, consumers purchase

many units of a good over time
Demand for that good declines with
increased consumption
 Electricity, water, heating fuel
Firms can engage in second-degree price
discrimination
 Practice of charging different prices per unit for
different quantities of the same good or service

Second-Degree Price
Discrimination
 Quantity discounts are an example of

second-degree price discrimination
Ex: Buying in bulk at Sam’s Club
 Block pricing – the practice of charging
different prices for different quantities of
“blocks” of a good
Ex: electric power companies charge
different prices for a consumer purchasing a
set block of electricity

Second-Degree Price Discrimination
$/Q Without discrimination:
Different prices are
charged for different P = P0 and Q = Q0. With
P1 quantities or second-degree
“blocks” of same discrimination there are
P0 good. three blocks with prices
P1, P2, & P3.
P2
AC
P3 MC
D
MR
Q1 Q0 Q2 Q3 Quantity
1st Block 2nd Block 3rd Block
Third-Degree Price Discrimination
 Practice of dividing consumers into two

or more groups with separate demand
curves and charging different prices to
each group
1. Divides the market into two groups
2. Each group has its own demand function

 Third Degree Price Discrimination

 Most common type of price discrimination
Examples: airlines, premium vs. non-
premium liquor, discounts to students and
senior citizens, frozen vs. canned vegetables

 Same characteristic is used to divide the

consumer groups
 Typically, elasticities of demand differ for
the groups
College students and senior citizens are not
usually willing to pay as much as others
because of lower incomes
These groups are easily distinguishable with
ID’s

Creating Consumer Groups
 If third-degree price discrimination is

feasible, how can the firm decide what
to charge each group of consumers?
1. Total output should be divided between
groups so that MR for each group is equal
2. Total output is chosen so that MR for each
group of consumers is equal to the MC of
production

Third-Degree Price
Discrimination
 Algebraically
P1: price first group
P2: price second group
C(QT) = total cost of producing output
QT = Q 1 + Q 2
Profit:  = P1Q1 + P2Q2 - C(QT)

Third-Degree Price
Discrimination
 Firm should increase sales to each group

until incremental profit from last unit sold
is zero
 Set incremental  for sales to group 1 = 0
 ( P1Q1 ) C
  0
Q1 Q1 Q1
( P1Q1 ) C
 MR1  MC
Q1 Q1
Third-Degree Price
Discrimination
 First group of consumers:

MR1= MC
 Can do the same thing for the second
group of consumers
 Second group of customers:
MR2 = MC
 Combining these conclusions gives
MR1 = MR2 = MC

Third-Degree Price
Discrimination
 Determining relative prices

Thinking of relative prices that should be
charged to each group of consumers and
relating them to price elasticities of demand
may be easier
Recall: MR  P 1  1 Ed 
Then: MR1  P1 (1  1 E1 )  MR2  P2 (1  1 E2 )
E1 and E2 elasticities of demand for each group

Third-Degree Price
Discrimination
 Determining relative prices

Equating MR1 and MR2 gives the following
relationship that must hold for prices
The higher price will be charged to consumer
with the lower demand elasticity
P1 ( 1  1 E 2 )

P2 ( 1  1 E1 )

Third-Degree Price
Discrimination
 Example
E1 = -2 and E2 = -4
P1 should be 1.5 times as high as P2
P1 (1  1 4) 3 / 4
   1.5
P2 (1  1 2) 1 / 2

$/Q Consumers are divided into
two groups, with separate
demand curves for each group.
MRT = MR1 + MR2
D2 = AR2
MRT
MR2
MR1 D1 = AR1
Quantity
$/Q •QT: MC = MRT
MC = MR1 at Q1 and P1
•Group 1: more inelastic
•Group 2: more elastic
P1 •MR1 = MR2 = MCT
•QT control MC
MC
P2
MCT D2 = AR2
MRT
MR2
MR1 D1 = AR1
Q1 Q2 QT Quantity
No Sales to Smaller Market
 Even if third-degree price discrimination

is possible, it may not be feasible to try to
sell to both groups
It is possible that the demand for one group
is so low that it would not be profitable to
lower price enough to sell to that group

No Sales to Smaller Market
$/Q Group one, with
demand D1, is not
willing to pay enough
MC for the good to make
price discrimination
P* profitable.
D2
MC=MR1
=MR2
MR2
D1
MR1
Q* Quantity
The Economics of Coupons
and Rebates
 Those consumers who are more price

elastic will tend to use the coupon/rebate
more often when they purchase the
product than those consumers with a less
elastic demand
 Coupons and rebate programs allow
firms to price discriminate

The Economics of Coupons
and Rebates
 About 20 – 30% of consumers use

coupons or rebates
 Firms can get those with higher
elasticities of demand to purchase the
good who would not normally buy it
 Table 11.1 shows how elasticities of
demand vary for coupon/rebate users
and non-users

Price Elasticities of Demand:
Users vs. Nonusers of Coupons

Airline Fares
 Differences in elasticities imply that some

customers will pay a higher fare than
others
 Business travelers have few choices and
their demand is less elastic
 Casual travelers and families are more
price-sensitive and will therefore be
choosier

Elasticities of Demand for
Air Travel

Airline Fares
 There are multiple fares for every route
flown by airlines
 They separate the market by setting
various restrictions on the tickets
Must stay over a Saturday night
21-day advance, 14-day advance
Basic restrictions – can change ticket to only
certain days
Most expensive: no restrictions – first class

Other Types of Price
Discrimination
 Intertemporal Price Discrimination
Practice of separating consumers with
different demand functions into different
groups by charging different prices at
different points in time
Initial release of a product, the demand is
inelastic
 Hard back vs. paperback book
 New release movie
 Technology

Intertemporal Price
Discrimination
 Once this market has yielded a maximum

profit, firms lower the price to appeal to a
general market with a more elastic
demand
 This can be seen graphically looking at
two different groups of consumers – one
willing to buy right now and one willing to
wait

Intertemporal Price
Discrimination
$/Q
Initially, demand is less Over time, demand becomes
elastic, resulting in a more elastic and price
P1 price of P1 . is reduced to appeal to the
mass market.
P2
D2 = AR2
AC = MC
MR2
MR1 D1 = AR1
Q1 Q2 Quantity
Other Types of Price
Discrimination
 Peak-Load Pricing
Practice of charging higher prices during
peak periods when capacity constraints
cause marginal costs to be higher
 Demand for some products may peak at
particular times
Rush hour traffic
Electricity - late summer afternoons
Ski resorts on weekends

Peak-Load Pricing
 Objective is to increase efficiency by

charging customers close to marginal
cost
Increased MR and MC would indicate a
higher price
Total surplus is higher because charging
close to MC
Can measure efficiency gain from peak-load
pricing

Peak-Load Pricing
 With third-degree price discrimination,

the MR for all markets was equal
 MR is not equal for each market because
one market does not impact the other
market with peak-load pricing
Price and sales in each market are
independent
Ex: electricity, movie theaters

Peak-Load Pricing
$/Q MC MR=MC for each
group. Group 1
P1 has higher
demand during
peak times.
D1 = AR1
P2
MR1
D2 = AR2
MR2
Q2 Q1 Quantity
How to Price a Best-Selling
Novel
 How would you arrive at the price for the
initial release of the hardbound edition of
a book?
Hardback and paperback books are ways for
the company to price discriminate
How does the company determine what price
to sell the hardback and paperback books
for?
How does the company determine when to
release the paperback?

Novel
 Company must divide consumers into

two groups:
Those willing to buy the more expensive
hardback
Those willing to wait for the paperback
 Have to be strategic about when to
release paperback after hardback
Publishers typically wait 12 to 18 months

Novel
 Publishers must use estimates of past
books to determine how much to sell a
new book for
 Hard to determine the demand for a
NEW book
 New books are typically sold for about
the same price, to take this into account
 Demand for paperbacks is more elastic
so we should expect it to be priced lower

The Two-Part Tariff
 Form of pricing in which consumers are charged
both an entry and usage fee
 Ex: amusement park, golf course, telephone service
 A fee is charged upfront for right to use/buy the
product
 An additional fee is charged for each unit the
consumer wishes to consume
 Pay a fee to play golf and then pay another fee for
each game you play

The Two-Part Tariff
 Pricing decision is setting the entry fee
(T) and the usage fee (P)
 Choosing the trade-off between free-
entry and high-use prices or high-entry
and zero-use prices
 Single Consumer
Assume firm knows consumer demand
Firm wants to capture as much consumer
surplus as possible

Two-Part Tariff with a Single
Consumer
$/Q Usage price P* is set equal to MC.
Entry price T* is equal to the entire
T* consumer surplus.
Firm captures all consumer
surplus as profit.
MC
P*
Quantity
Two-Part Tariff with Two
Consumers
 Two consumers, but firm can only set one entry
fee and one usage fee
 Will no longer set usage fee equal to MC
 Could make entry fee no larger than CS of consumer
with smallest demand
 Firm should set usage fee above MC
 Set entry fee equal to remaining consumer
surplus of consumer with smaller demand
 Firm needs to know demand curves

Two-Part Tariff with Two
Consumers
$/Q The price, P*, will be
T* greater than MC. Set T*
at the surplus value of D2.
A
  2T *  ( P *  MC )(Q1  Q2 )
 more than twice ABC
MC
B
C D1 = consumer 1
D2 = consumer 2
Q2 Q1 Quantity
The Two-Part Tariff with Many
Consumers
 No exact way to determine P* and T*

 Must consider the trade-off between the
entry fee T* and the use fee P*
Low entry fee: more entrants and more profit
from sales of item
As entry fee becomes smaller, number of
entrants is larger and profit from entry fee will
fall

The Two-Part Tariff with Many
Consumers
 To find optimum combination, choose

several combinations of P and T
 Find combination that maximizes profit
 Firm’s profit is divided into two
components
Each is a function of entry fee, T assuming a
fixed sales price, P

Two-Part Tariff with Many
Different Consumers
Profit    a   s  n(T )T  ( P  MC )Q(n)
n  entrants
Total profit is the sum of the
profit from the entry fee and
the profit from sales. Both
depend on T.
 Total
 a :entry fee
 s:sales
T* T
The Two-Part Tariff
 Rule of Thumb
Similar demand: Choose P close to MC and
high T
Dissimilar demand: Choose high P and low T
Ex: Disneyland in California and Disney
world in Florida have a strategy of high entry
fee and charge nothing for ride

The Two-Part Tariff With a Twist
 Entry price (T) entitles the buyer to a certain
number of free units
 Gillette razors sold with several blades
 Amusement park admission comes with some tokens
 On-line fees with free time
 Can set higher entry fee without losing many
consumers
 Higher entry fee captures either surplus without
driving them out of the market
 Captures more surplus of large customers

Polaroid Cameras
 In 1971, Polaroid introduced the SX-70

camera
 Polaroid was able to use two-part tariff for
pricing of camera/film
Allowed them greater profits than would have
been possible if camera used ordinary film
 Polaroid had a monopoly on cameras
and film

Polaroid Cameras
 Buying camera is like entry fee
 Unlike an amusement park, for example, the
marginal cost of providing an additional camera
is significantly greater than zero
 It was necessary for Polaroid to have monopoly
 If ordinary film could be used, the price of film would
be close to MC
 Polaroid needed to gain most of its profits from sale of
film

Polaroid Cameras
 Analytical framework:
  PQ  nT  C1 (Q)  C2 (n)
P  price of film
T  price of camera
Q  quantity of film sold
n  number of cameras sold
C1 (Q)  cost of producing film
C2 (n)  cost of producing cameras
Polaroid Cameras
 In the end, the film prices were

significantly above marginal cost
 There was considerable heterogeneity of
consumer demands

Cellular Rate Plans
 In most areas in US, consumers can choose
cellular providers: Verizon, Cingular, AT&T and
Sprint
 Market power exists because consumers face
switching costs
 When they sign up with a firm, they must sign a
contract with high costs to break
 Plans often exist of monthly cost plus fee extra
minutes
 Companies can combine third-degree price
discrimination with two-part tariff

Cellular Rate Plans

Cellular Rate Plans

Bundling
 Bundling is packaging two or more

products to gain a pricing advantage
 Conditions necessary for bundling
Heterogeneous customers
Price discrimination is not possible
Demands must be negatively correlated

Bundling
 When film company leased “Gone with

the Wind,” it required theaters to also
lease “Getting Gertie’s Garter”
 Why would a company do this?
Company must be able to increase revenue
We can see the reservation prices for each
theater and movie

Bundling
Gone with the Wind Getting Gertie’s Garter
Theater A $12,000 $3,000

Theater B $10,000 $4,000
 Renting the movies separately would result

in each theater paying the lowest
reservation price for each movie:
Maximum price Wind = $10,000
Maximum price Gertie = $3,000
 Total Revenue = $26,000
Bundling
 If the movies are bundled:

Theater A will pay $15,000 for both
Theater B will pay $14,000 for both
 If each were charged the lower of the two
prices, total revenue will be $28,000
 The movie company will gain more
revenue ($2000) by bundling the movie

Relative Valuations
 More profitable to bundle because

relative valuation of two films are
reversed
 Demands are negatively correlated
A pays more for Wind ($12,000) than B
($10,000)
B pays more for Gertie ($4,000) than A
($3,000)

Relative Valuations
 If the demands were positively correlated

(Theater A would pay more for both films
as shown) bundling would not result in an
increase in revenue
Gone with the Wind Getting Gertie’s Garter
Theater A $12,000 $4,000

Theater B $10,000 $3,000

Bundling
 If the movies are bundled:

Theater A will pay $16,000 for both
Theater B will pay $13,000 for both
 If each were charged the lower of the two
prices, total revenue will be $26,000, the
same as by selling the films separately

Bundling
 Bundling Scenario: Two different goods

and many consumers
Many consumers with different reservation
price combinations for two goods
Can show graphically the preferences of
consumers in terms of reservation prices and
consumption decisions given prices charged
r1 is reservation price of consumer for good 1
r2 is reservation price of consumer for good 2

Reservation Prices
r2
For example,
Consumer C Consumer A is
willing to pay up to
$10 $3.25 for good 1
and up to $6 for
good 2.
Consumer A
$6
Consumer B
$3.25
$3.25 $8.25 $10 r1

Consumption Decisions When
Products are Sold Separately
r2 R1  P1 R1  P1 Consumers fall into
R2  P2 R2  P2 four categories based
on their reservation
II I price.
Consumers buy Consumers buy
only Good 2 both goods
P2
R1  P1 R1  P1
R2  P2 R2  P2
III IV
Consumers buy Consumers buy
neither good only Good 1
P1 r1
Consumption Decisions When
Products are Bundled
r2 Consumers buy the bundle
when r1 + r2 > PB
I (PB = bundle price).
PB = r1 + r2 or r2 = PB - r1
Consumers
Region 1: r > PB
buy bundle
(r > PB) Region 2: r < PB
r2 = PB - r1
II
Consumers do
not buy bundle
(r < PB)
r1
Consumption Decisions
When Products are Bundled
 The effectiveness of bundling depends

upon the degree of negative correlation
between the two demands
Best when consumers who have high
reservation price for Good 1 have a low
reservation price for Good 2 and vice versa
Can see graphically looking at positively and
negatively correlated prices

Reservation Prices
r2
If the demands are
perfectly positively
correlated, the firm
will not gain by bundling.
It would earn the same
profit by selling the
goods separately.
P2
P1 r1
Reservation Prices
r2
If the demands are perfectly
negatively correlated,
bundling is the ideal
strategy – all the
consumer surplus can be
extracted and a higher
profit results.
r1
Movie Example
(Gertie) r2
10,000 Bundling pays due to

negative correlation.
5,000 B
4,000
A
3,000
5,000 10,000 12,000 14,000 r1 (Wind)

Mixed Bundling
 Practice of selling two or more goods

both as a package and individually
 This differs from pure bundling when
products are sold only as a package
 Mixed bundling is good strategy when
Demands are somewhat negatively
correlated
Marginal production costs are significant

Mixed Bundling – Example
 Demands are perfectly negatively

correlated but significant marginal costs
 Four customers under three different
strategies
Selling good separately, P1 = $50, P2 = $90
Selling goods only as a bundle, PB = $100
Mixed bundling:
 Sold individually with P1 = P2 = $89.95
 Sold as a bundle with PB = $100

Mixed Bundling – Example
 We can see the effects under different

scenarios in the following table:

Mixed Versus Pure Bundling
r2 C1 = MC1
C1 = 20 With positive marginal
100 costs, mixed bundling
A
may be more profitable
90 than pure bundling.
80
For each good, marginal production
70 cost exceeds reservation price of one
consumer.
60 •A and D will buy individually
B •B and C will buy bundle
50
C
40
30 C2 = MC2
C2 = 30
20
D
10
10 20 30 40 50 60 70 80 90 100 r1
Bundling
 If MC is zero, mixed bundling can still be

more profitable if consumer demands are
not perfectly negatively correlated
 Example:
Reservation prices for consumers B and C
are higher
Compare the same three strategies
Mixed bundling is the more profitable option
since everyone will end up buying

Mixed Bundling with Zero
Marginal Costs
r2 120
A and D purchase individually.

100 B and C purchase bundled.
A Profits are highest with mixed bundling.
90
B
80
60
C
40
20
10 D
10 20 Inc. 40 60 80 90 100 120

r1
©2005 Pearson Education, 84
Bundling in Practice
 Car purchasing
Bundles of options such as electric locks with
air conditioning
 Vacation Travel
Bundling hotel with air fare
 Cable television
Premium channels bundled together

Bundling
 Mixed Bundling in Practice

Use of market surveys to determine
reservation prices
Design a pricing strategy from the survey
results
 Can show graphically using information
collected from consumers
Consumers are separated into four regions
Can change prices to find max profits

Mixed Bundling in Practice
r2
The firm can first choose a price
for the bundle and then try individual
PB prices P1 and P2 until total profit
is roughly maximized.
P2
P1 PB r1

A Restaurant’s Pricing Problem

Tying
 The practice of requiring a customer to

purchase one good in order to purchase
another
Xerox machines and the paper
IBM mainframe and computer cards
 Allows firm to meter demand and practice
price discrimination more effectively

Tying
 Allows the seller to meter the customer

and use a two-part tariff to discriminate
against the heavy user
McDonald’s
 Allows them to protect their brand name
Microsoft
 Uses to extend market power

Advertising
 Firms with market power have to decide

how much to advertise
 We can show how firms choose profit
maximizing advertising
Decision depends on characteristics of
demand for firm’s product

Advertising
 Assumptions
Firm sets only one price for product
Firm knows quantity demanded depends on
price and advertising expenditure dollars, A
Q(P,A)
We can show the firm’s cost curves, revenue
curves, and profits under advertising and no
advertising

Effects of Advertising
AR andfirm
If the MRadvertises,
are average
$/Q 1 and
its marginal
the
revenue
average and
firm doesn’t
revenue
when
marginal
curvesadvertise.
shift to
MC the right -- average costs
rise, but marginal cost
P1 does not.
AR’
AC’
P0 AC
0 MR’
AR
MR
Q0 Q1 Quantity
Advertising
 Choosing Price and Advertising

Expenditure
  PQ( P , A)  C (Q )  A
Q Q
MR Ads  P  1  MC  full MC of adv.
A A

Advertising
 A Rule of Thumb for Advertising
( P  MC ) / P  1 / EP for pricing
Q
( P-MC ) 1
A
P  MC  A Q  A
    Adv. to sales ratio
P  Q A  PQ

Advertising
( A Q)( Q A)  E A  Adv. elasticity of demand

( P  MC ) P   1 EP
A PQ  ( E A EP )  Rule of Thumb

Advertising

To maximize profit, the firm’s advertising-to-
sales ratio should be equal to minus the ratio
of the advertising and price elasticities of
demand

Advertising
 An Example
R(Q) = $1 million/yr
$10,000 budget for A (advertising--1% of
revenues)
EA = .2 (increase budget $20,000, sales
increase by 20%)
EP = -4 (markup price over MC is substantial)

Advertising
 The firm in our example should increase

advertising
A/PQ = -(2/-.4) = 5%
Increase budget to $50,000

Advertising – In Practice
 Estimate the level of advertising for each
of the firms
Supermarkets
 EP = -10; EA = 0.1 to 0.3
Convenience stores
 EP = -5; EA very small
Designer jeans
 EP = -3 to –4; EA = 0.3 to 1
Laundry detergents
 EP = -3 to –4; EA very large

Pricing With Market Power

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Chapter 11

Pricing with Market Power

 Capturing Consumer Surplus

©2005 Pearson Education, Inc. Chapter 11 2

 Pricing without market power (perfect

©2005 Pearson Education, Inc. Chapter 11 3

 Pricing with market power (imperfect

©2005 Pearson Education, Inc. Chapter 11 4

©2005 Pearson Education, Inc. Chapter 11 5

©2005 Pearson Education, Inc. Chapter 11 7

©2005 Pearson Education, Inc. Chapter 11 8

 If the firm can price discriminate perfectly,

©2005 Pearson Education, Inc. Chapter 11 9

With perfect discrimination, firm

 In practice, perfect price discrimination

©2005 Pearson Education, Inc. Chapter 11 11

 Examples of imperfect price

©2005 Pearson Education, Inc. Chapter 11 12

©2005 Pearson Education, Inc. Chapter 11 13

 In some markets, consumers purchase

©2005 Pearson Education, Inc. Chapter 11 14

 Quantity discounts are an example of

©2005 Pearson Education, Inc. Chapter 11 15

 Practice of dividing consumers into two

©2005 Pearson Education, Inc. Chapter 11 17

 Third Degree Price Discrimination

©2005 Pearson Education, Inc. Chapter 11 18

 Same characteristic is used to divide the

©2005 Pearson Education, Inc. Chapter 11 19

 If third-degree price discrimination is

©2005 Pearson Education, Inc. Chapter 11 20

©2005 Pearson Education, Inc. Chapter 11 21

 Firm should increase sales to each group

 First group of consumers:

©2005 Pearson Education, Inc. Chapter 11 23

 Determining relative prices

©2005 Pearson Education, Inc. Chapter 11 24

 Determining relative prices

©2005 Pearson Education, Inc. Chapter 11 25

©2005 Pearson Education, Inc. Chapter 11 26

MRT = MR1 + MR2

 Even if third-degree price discrimination

©2005 Pearson Education, Inc. Chapter 11 29

 Those consumers who are more price

©2005 Pearson Education, Inc. Chapter 11 31

 About 20 – 30% of consumers use

©2005 Pearson Education, Inc. Chapter 11 32

©2005 Pearson Education, Inc. Chapter 11 33

 Differences in elasticities imply that some

©2005 Pearson Education, Inc. Chapter 11 34

©2005 Pearson Education, Inc. Chapter 11 35

©2005 Pearson Education, Inc. Chapter 11 36

©2005 Pearson Education, Inc. Chapter 11 37

 Once this market has yielded a maximum

©2005 Pearson Education, Inc. Chapter 11 38

©2005 Pearson Education, Inc. Chapter 11 40

 Objective is to increase efficiency by

©2005 Pearson Education, Inc. Chapter 11 41

 With third-degree price discrimination,