Chapter Twelve
Pricing and
Advertising
Topics
 Why and How Firms Price
Discriminate.
 Perfect Price Discrimination.
 Quantity Discrimination.
 Multimarket Price Discrimination.
 Two-Part Tariffs.
 Tie-In Sales.
 Advertising.
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Nonuniform pricing
 nonuniform pricing - charging
consumers different prices for the same
product or charging a single customer a
price that depends on the number of
units the customer buys
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Price discrimination
 Price discrimination - practice in which
a firm charges consumers different
prices for the same good
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Why Price Discrimination Pays
 A price-discriminating firm earns a
higher profit from price discrimination
because:
 it charges a higher price to customers who
are willing to pay more than the uniform
price, capturing some or all of their
consumer surplus
 it sells to some people who were not willing
to pay as much as the uniform price.
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Table 12.1 A Theater’s Profit Based
on the Pricing Method Used
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Who Can Price Discriminate
 Three conditions:
 a firm must have market power.
 consumers must differ in their sensitivity to
price, and a firm must be able to identify
how consumers differ in this sensitivity.
 a firm must be able to prevent or limit
resales
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Not All Price Differences Are Price
Discrimination
 Not every seller who charges
consumers different prices is price
discriminating.
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Types of Price Discrimination
 perfect price discrimination (firstdegree price discrimination) - situation in
which a firm sells each unit at the
maximum amount any customer is
willing to pay for it, so prices differ
across customers and a given customer
may pay more for some units than for
others
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12-9
Types of Price Discrimination (cont).
 quantity discrimination (seconddegree price discrimination) - situation in
which a firm charges a different price for
large quantities than for small quantities
but all customers who buy a given
quantity pay the same price
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Perfect Price Discrimination
 multimarket price discrimination
(thirddegree price discrimination) - a
situation in which a firm charges
different groups of customers different
prices but charges a given customer the
same price for every unit of output sold
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Perfect Price Discrimination (cont).
 reservation price - the maximum
amount a person would be willing to pay
for a unit of output
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Figure 12.1 Perfect Price
Discrimination
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Perfect Price Discrimination: Efficient
But Hurts Consumers
 A perfect price discrimination equilibrium
is efficient and maximizes total welfare.
 Perfect price discrimination equilibrium
differs from the competitive equilibrium
in two ways:
 perfect price discrimination equilibrium, only
the last unit is sold at that price.
 perfectly price-discriminating monopoly
captures all the welfare.
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p, $ per unit
Figure 12.2 Competitive, Single-Price,
and Perfect Discrimination Equilibria
p1
MC
A
es
ps
B
C
ec
pc = MCc
E
D
MCs
Demand, MRd
MC1
MRs
Qs
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Qc = Qd
Q, Units per day
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Figure 12.2 Competitive, Single-Price, and
Perfect Discrimination Equilibria (cont.)
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Application Botox Revisited
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Solved Problem 12.1
 How does welfare change if the movie
theater described in Table 12.1 goes
from charging a single price to perfectly
price discriminating?
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Solved Problem 12.2
 Competitive firms are the customers of a
union, which is the monopoly supplier of labor
services. Show the union’s “producer surplus”
if it perfectly price discriminates. Then
suppose that the union makes the firms a
take-it-or-leave-it offer: They must guarantee
to hire a minimum of H* hours of work at a
wage of w*, or they can hire no one. Show
that by setting w* and H* appropriately, the
union can achieve the same outcome as if it
could perfectly price discriminate.
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Solved Problem 12.2
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Quantity Discrimination
 Most customers are willing to pay more
for the first unit than for successive
units:
 the typical customer’s demand curve is
downward sloping.
 block-pricing schedules - charge one
price for the first few units (a block) of
usage and a different price for
subsequent blocks.
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(a) Quantity Discrimination
(b) Single-Price Monopoly
p1, $ per unit
p2, $ per unit
Figure 12.3 Quantity Discrimination
90
A=
$200
90
70
E = $450
60
C=
$200
50
B=
$1,200
F = $900
D=
$200
G = $450
m
30
m
30
Demand
Demand
MR
0
20
40
90
Q, Units per day
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0
30
90
Q, Units per day
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Figure 12.3 Quantity Discrimination
(cont.)
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Multimarket Price Discrimination
 The most common method of
multimarket price discrimination is to
divide potential customers into two or
more groups and set a different price for
each group.
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Multimarket Price Discrimination with
Two Groups
 A copyright gives Warner Home
Entertainment the legal monopoly to
produce and sell the Harry Potter and
the Prisoner of Azkaban two-DVD movie
set, which it released in November
2004.
 Warner engages in multimarket price
discrimination by charging different prices
in various countries because it believes that
the elasticities of demand differ compared
to the U.S. price
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Multimarket Price Discrimination with
Two Groups (cont).
π = πA + πB = [pAQA − mQA] + [pBQB − mQB]
 pAQA = revenue from American customers
 pBQB = revenue from British customers
 π = American and British profits
 Warner sets its quantities so that the marginal
revenue for each group equals the common
marginal cost, m, which is about $1 per unit.
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Multimarket Price Discrimination with
Two Groups (cont).
 Because the monopoly equates the marginal
revenue for each group to its common marginal
cost, :
MRA = m = MRB.
 Therefore, using price elasticities:


1
1
MR  p A 1    m  pB 1    MR B
 A 
 B 
A
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Multimarket Price Discrimination with
Two Groups (cont).
 From previous slide:


1
1
MR  p A 1    m  pB 1    MR B
 A 
 B 
A
 and rearranging,
1
1
pA
A

pB 1  1
B
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12-28
Figure 12.4 Multimarket Pricing of
Harry Potter DVD
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Solved Problem 12.3
 A monopoly drug producer with a
constant marginal cost of m = 1 sells in
only two countries and faces a linear
demand curve of Q1 = 12 − 2p1 in
Country 1 and Q2 = 9 − p2 in Country 2.
What price does the monopoly charge in
each country, how much does it sell in
each, and what profit does it earn in
each with and without a ban against
shipments between the countries?
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Solved Problem 12.3
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Solved Problem 12.3 (cont’d)
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Identifying Groups
 Two approaches to divide customers
into groups:
 divide buyers into groups based on
observable characteristics of consumers.
 identify and divide consumers on the basis
of their actions
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Welfare Effects of Multimarket Price
Discrimination
 Multimarket price discrimination results
in inefficient production and
consumption.
 As a result, welfare under multimarket price
discrimination is lower than that under
competition or perfect price discrimination.
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Two-Part Tariffs
 two-part tariff - a pricing system in
which the firm charges a customer a
lump-sum fee (the first tariff or price) for
the right to buy as many units of the
good as the consumer wants at a
specified price (the second tariff)
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A Two-Part Tariff with Identical
Consumers
 A monopoly that knows its customers’
demand curve can set a two-part tariff
that has the same two properties as the
perfect price discrimination equilibrium.
 the efficient quantity, Q1, is sold because
the price of the last unit equals marginal
cost.
 all consumer surplus is transferred from
consumers to the firm.
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Figure 12.5 Two-Part Tariff
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Tie-In Sales
 tie-in sale- a type of nonlinear pricing in
which customers can buy one product
only if they agree to buy another product
as well.
 requirement tie - in sale a tie-in sale in
which customers who buy one product
from a firm are required to make all their
purchases of another product from that
firm
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Tie-In Sales (cont).
 bundling (package tie-in sale) - a type
of tie-in sale in which two goods are
combined so that customers cannot buy
either good separately.
 bundling a pair of goods pays only if their
demands are negatively correlated:
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Table 12.2 Bundling of Tickets to
Football Game
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Advertising
 A monopoly advertises to raise its profit.
 A successful advertising campaign shifts
the market demand curve by changing
consumers’ tastes or informing them about
new products.
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The Decision Whether to Advertise
 Even if advertising succeeds in shifting
demand, it may not pay for the firm to
advertise.
 If advertising shifts demand outward, the
firm’s gross profit must rise.
 The firm undertakes this advertising
campaign only if it expects its net profit
(gross profit minus the cost of advertising)
to increase.
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Price of Co ke, p c , $ per unit
Figure 12.6 Advertising
19
17
p2 = 12
p1 = 11
e2
B
e1
1
MC = AC
5
MR 1
0
Q1 = 24 Q 2 = 28
MR 2
D1
D2
68
76
Qc , Units of Co ke per year
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Marginal benefit, marginal cost, $ per unit
Figure 12.7 Shift in the Marginal Benefit
of Advertising
MB 2
MB 1
MC
A2
A1
Minutes of advertising time purchased per day
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Cross-Chapter Analysis: Magazine
Subscriptions
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