1
CHAPTER
11
Pricing with
Market Power
Prepared by:
Fernando & Yvonn Quijano
© 2008 Prentice Hall Business Publishing • Microeconomics • Pindyck/Rubinfeld, 7e.
2 11.1 CAPTURING CONSUMER SURPLUS
Figure 11.1
Capturing Consumer Surplus
If a firm can charge only one price for
all its customers, that price will be P*
and the quantity produced will be Q*.
Ideally, the firm would like to charge a
higher price to consumers willing to
pay more than P*, thereby capturing
Chapter 11: Pricing with Market Power
some of the consumer surplus under
region A of the demand curve.
The firm would also like to sell to
consumers willing to pay prices lower
than P*, but only if doing so does not
entail lowering the price to other
consumers.
In that way, the firm could also
capture some of the surplus under
region B of the demand curve.
● price discrimination Practice of charging different
prices to different consumers for similar goods.
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3 11.2 PRICE DISCRIMINATION
First-Degree Price Discrimination
● reservation price Maximum price that a customer
is willing to pay for a good.
● first-degree price discrimination Practice of
charging each customer her reservation price.
Figure 11.2
Additional Profit from Perfect First-Degree
Chapter 11: Pricing with Market Power
Price Discrimination
Because the firm charges each consumer her
reservation price, it is profitable to expand
output to Q**.
When only a single price, P*, is charged, the
firm’s variable profit is the area between the
marginal revenue and marginal cost curves.
With perfect price discrimination, this profit
expands to the area between the demand
curve and the marginal cost curve.
● variable profit Sum of profits on each incremental
unit produced by a firm; i.e., profit ignoring fixed costs.
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4 11.2 PRICE DISCRIMINATION
First-Degree Price Discrimination
Perfect Price Discrimination
The additional profit from producing and selling an incremental
unit is now the difference between demand and marginal cost.
Imperfect Price Discrimination
Figure 11.3
Chapter 11: Pricing with Market Power
First-Degree Price Discrimination in
Practice
Firms usually don’t know the
reservation price of every
consumer, but sometimes
reservation prices can be roughly
identified.
Here, six different prices are
charged. The firm earns higher
profits, but some consumers may
also benefit.
With a single price P*4, there are
fewer consumers.
The consumers who now pay P5 or
P6 enjoy a surplus.
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5 11.2 PRICE DISCRIMINATION
Second-Degree Price Discrimination
● second-degree price discrimination Practice of charging different
prices per unit for different quantities of the same good or service.
● block pricing Practice of charging different prices for different
quantities or “blocks” of a good.
Figure 11.4
Chapter 11: Pricing with Market Power
Second-Degree Price Discrimination
Different prices are charged for
different quantities, or “blocks,” of
the same good. Here, there are
three blocks, with corresponding
prices P1, P2, and P3.
There are also economies of
scale, and average and marginal
costs are declining. Second-
degree price discrimination can
then make consumers better off
by expanding output and lowering
cost.
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6 11.2 PRICE DISCRIMINATION
Third-Degree Price Discrimination
● third-degree price discrimination Practice of dividing consumers
into two or more groups with separate demand curves and charging
different prices to each group.
Creating Consumer Groups
If third-degree price discrimination is feasible, how should the firm decide
Chapter 11: Pricing with Market Power
what price to charge each group of consumers?
1. We know that however much is produced, total output should be
divided between the groups of customers so that marginal revenues
for each group are equal.
2. We know that total output must be such that the marginal revenue
for each group of consumers is equal to the marginal cost of
production.
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7 11.3 INTERTEMPORAL PRICE DISCRIMINATION
AND PEAK-LOAD PRICING
Publishing both hardbound and paperback
editions of a book allows publishers to price
discriminate.
Some consumers want to buy a new
bestseller as soon as it is released, even if
Chapter 11: Pricing with Market Power
the price is $25. Other consumers, however,
will wait a year until the book is available in
paperback for $10.
The key is to divide consumers into two groups, so that those who are
willing to pay a high price do so and only those unwilling to pay a high
price wait and buy the paperback.
It is clear, however, that those consumers willing to wait for the paperback
edition have demands that are far more elastic than those of bibliophiles.
It is not surprising, then, that paperback editions sell for so much less than
hardbacks.
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