More on monopoly
Today: Why single-price profit
maximization is typically
inefficient; price discrimination
Today

Profit maximization of the monopolist

As usual, set MB = MC to maximize profit



Revenue is the benefit for the monopolist
Remember that MB is decreasing for the
monopolist
Price discrimination and efficiency



Discounts
Perfect price discrimination
Rebates and coupons
Single-price profit
maximization


Remember that
marginal revenue is
below the price
received by the
monopolist (except
for the first unit in a
discrete case)
See our continuous
example we will use
today
Single-price profit
maximization


We will find the
point where MR and
MC are equal
Surplus and
deadweight loss will
then be calculated

MR has same
vertical intercept as
D, with twice the
slope

Read Ch. 10
Appendix for
algebraic approach
to solving monopoly
problems
Simple monopoly example

For this problem,
note:



Linear downwardsloping demand
curve
Linear upwardsloping MC curve
Remember: We
maximize profit by
setting MR = MC
Simple monopoly example

In an efficient
market with many
buyers and
sellers, point I is
the intersection of
the supply (MC)
and demand
curves

Price is G,
quantity is H
Simple monopoly example

As we will see with a
monopoly, a
different, less
efficient outcome,
occurs


MR = MC at point K
At quantity A, the
monopolist can see
from point E on the
demand curve that
price C can be
charged
Simple monopoly example

Calculating surplus if
this was an efficient
market

Recall that triangle
JI0 is total surplus in
an efficient market


Triangle JIG for
consumers
Triangle GI0 for
suppliers
Simple monopoly example



At price C,
consumer surplus
falls to triangle
JCE
TR for monopolist
is price C times
quantity A
Surplus for
monopolist is
trapezoid CEK0
Simple monopoly example

What is lost?


Triangle EIK is
lost, since the
monopolist stops
producing once
quantity reaches
A
This triangle is
deadweight loss
(DWL)
Why does DWL occur?



Marginal PUBLIC benefit comes from the
demand curve
Marginal PRIVATE benefit of the monopolist
comes from the marginal benefit curve
The socially optimal point comes from
Marginal PUBLIC benefit

The monopolist ignores this when making its
decisions
Price discrimination

Price discrimination can take many forms



Discounts of goods and services that have little or
no value if transferred to another person
Perfect price discrimination, where a different
price can be charged to each person
Rebates, which require effort to get a discount
Discounts in some businesses
with at least some market power

Simple discount examples

Discounts at a movie theater





Seniors
Students
Matinees and “twilight” showings
5% senior discount at a store on Tuesdays
Super $5 Monday (Expos/Padres)
Why are these types of
discounts offered?

All of these discounts are applied
because demand at a given business
depends on the day of the week, the
time of day, and/or the average income
of a group of people
Why are these types of
discounts offered?

Price discrimination helps consumers
and business



More consumers are able to enter the
market
Businesses are able to make more profits
by segmenting markets
Business charges price to maximize profit
in each market
Discount example


10 people willing to pay a positive price to
see “Bad Action Movie 4”
5 Non-students


5 Students


Reservation prices of $10, $9, $8, $7, and $5
Reservation prices of $6, $4, $3.25, $2.50, and $1
Assume $1 in VC per moviegoer  Sell
another ticket if MR ≥ $1
Assumption in the following
analysis

Price charged will be equal to the
lowest reservation price of all people
sold to in a market


Any higher price will lower sales
Any slightly lower price will decrease
revenue without changing costs
What if there are no
discounts?
Type of person
Reservation price
($)
Total rev. ($)
MR ($)
10
NS
10
10
8
NS
9
18
6
NS
8
24
4
NS
7
28
2
S
6
30
0
NS
5
30
Sell 5th ticket, do not sell 6th
ticket; Price is $6
Type of person
Reservation price
($)
Total rev. ($)
MR ($)
10
NS
10
10
8
NS
9
18
6
NS
8
24
4
Only
one
student
buys a
ticket
NS
7
28
2
S
6
30
0
NS
5
30
What if we can segment the
market between NS and S?


We can continue to sell to the same
non-students while increasing sales to
students
We will now look at each market
separately
Still sell to 4 NS, but price goes
up to $7 to maximize profit
Type of person
Res. price ($)
Total rev. ($)
MR ($)
10
NS
10
10
8
NS
9
18
6
NS
8
24
4
NS
7
28
–3
NS
5
25
Sell to 3 students, at a price of
$3.25 each
Type of person
Res. price ($)
Total rev. ($)
MR ($)
6
S
6
6
2
S
4
8
1.75
S
3.25
9.75
0.25
S
2.50
10
-5
S
1
Remember: MC is $1 per moviegoer
5
Additional profits

Left to student: Calculate profit both
with and without price discrimination

You should find that profit is higher with
price discrimination
Ultimate price discrimination:
Airlines

Airlines probably use price
discrimination more than any other
business



Tickets are non-transferable
Discrimination based on date of purchase
Discrimination between First-class,
Business, and Economy seats
Airline price discrimination


Prices of various routes out of Santa Barbara
checked on different dates on United Airline’s
website
The lowest-cost flight was recorded


Some interesting ways to get between Santa
Barbara and another city at lowest cost (Example:
Santa Barbara to Los Angeles to Aspen to Denver)
All dates are 2008, for flights departing Santa
Barbara 2/8, and returning 2/10
Santa Barbara
to Denver
Date 1/23 1/25 1/28 1/30 1/31 2/1 2/3 2/5 2/6 2/7
of fare
DEN
351
351
351
351
351
351 746 746 790 790
All fares in dollars


Note that price generally goes up as time
progresses
People making late bookings often have
higher willingness to pay for flights
Santa Barbara to…
Date 1/23 1/25 1/28 1/30 1/31 2/1 2/3 2/5
of fare
2/6
2/7
JFK
600
600
730
730
360
360 730 730 1370 1370
DEN
351
351
351
351
351
351 746 746
790
790
MSY
592
592
491
495
592
495 796 796
796
796
ORD
402
402
462
314
314
314 612 762
762
762
IAD
573
573
856
330
330
330 959 959 1061 1061
All fares rounded to nearest dollar

Price sometimes changes more than once a week
What happened 1/30 to 2/1?
Date 1/23 1/25 1/28 1/30 1/31 2/1 2/3 2/5
of fare
JFK
600
600
730
DEN
351
351
351
MSY
592
592
491
ORD
402
402
462
IAD
573
573
856
730
351
495
314
330
360
351
592
314
330
360
351
495
314
330
2/6
730 730 1370 1370
746 746
790
790
796 796
796
796
612 762
762
762
959 959 1061 1061
All fares rounded to nearest dollar

2/7
Price significantly drops in some flights
From United’s website: A sale
from 1/29 to 2/1


4 Day U.S. sale
Airfare to dozens of U.S. cities--now on sale
through Friday
For a special 4 day period, United is dropping fares to
and from many of the country's most visited and
exciting destinations. Fly to or from Denver, San
Francisco, Los Angeles, Washington-Dulles, and more
during the month of February and save with these
low rates. Remember though, book on united.com
by this Friday, to take advantage!
Another sale held at the same
time (also from United’s website)


Chicago 4 day sale
Windy city deals are in the air
The Magnificent Mile, Millenium Park, and, of
course, the deep dish pizza, are all staples of
Chicago. Read more about Chicago. And
between now and this Friday, United has put
travel to and from Chicago on sale. Just
remember to book on united.com, where
you'll never pay a booking fee.
One other thing to note

These sales usually have many
limitations

Notice that one market examined did not
have any discounts during the sale


DEN
Other restrictions often apply


4-day US Sale: Stay must be 1-30 days; travel
only allowed through the end of February
Chicago Sale: Complete travel by March 10
If you ignore the sale…


Notice that price generally increases as
time progresses
This corresponds to people with a high
willingness to pay more often buy their
tickets close to the departure date
More price discrimination:
Last-minute fares


For flights that are not expected to fill
up, some airlines will lower the fare if
you are willing to buy no more than a
few days before the flight leaves
We will look at fares for SBA to JFK


Leaving Saturday 2/9
Returning Monday 2/11
More price discrimination:
Last-minute fares (SBA/JFK)

From lastminute.com


On United’s website, they advertise weekly efares for leaving on Saturday and returning
on Monday or Tuesday


American Airlines flight, $321
$326 fare
Similar United flight two weeks later costs
$575

Maybe check later to try for a better fare
Why does one day make a
difference?


We see that a last-minute fare can be
much lower if you leave Saturday and
return Monday (relative to Friday and
Sunday, respectively)
Why do airlines offer these deals?
Why does one day make a
difference?

Leisure travelers want to minimize the
amount of work missed



They often try to leave Friday for weekend
getaways
They want to return on Sunday
Saturday is often a good day to fly from the
flexible traveler’s viewpoint


Low demand for business travelers
Low demand for leisure travelers
Why does one day make a
difference?


Airlines know times of low demand
They price discriminate in order to fill
up planes, without losing revenue from
other customers

These offers often have many limitations

United’s e-fares: You must typically leave
Saturday and return two or three days later
More price discrimination


Spirit Airlines often has sale prices
below $50 for one-way tickets
However, restrictions are typically
extreme

Example: You must fly each way on a
Tuesday to get the sale fare
What if you were flexible?

On 1/31, you could have booked a
roundtrip from Fort Lauderdale to
Nassau, Bahamas for $9 each way if
your trip is from 2/12 – 2/26 (both
Tuesdays)

Even with taxes and fees, the total roundtrip fare is $104.80
What if you were flexible?

Another example on Spirit Airlines,
Orlando to Fort Lauderdale (same
dates), $19 each way


$59 round-trip with taxes and fees
Comparable in price to Greyhound’s 7-day
advance purchase fare ($58) and Amtrak’s
fare ($64)
Perfect price discrimination?

Airlines do not perfectly price
discriminate, but they are able to make
many more flights profitable by these
pricing practices


By price discriminating, airlines are able to
offer more flights to more places
Perfect price discrimination would
involve being able to charge a price
specific to each person
Hurdles: Rebates & coupons


Companies often use another method
to price discriminate
Customers are forced to seek a discount
if they want to receive it


Rebates: Force the customer to send in a
form to receive discount
Coupon: Make consumer find a coupon
before purchase to get a discount
Example of hurdle


Baseball teams often have lower
attendance in mid-week games against
bad teams
A baseball team may coordinate with a
sponsor

Hypothetical example: “Visit the Duff Bear
display at your local supermarket to get
your half-off coupon to select Isotope
home games”
Summary of monopoly, part 1


Price can be controlled by the monopolist
Various ways can be used to obtain market
power


Exclusive control over important inputs; Patents
and copyrights; Government licenses or
franchises; Economies of scale; Networks
Downward-sloping MR curve

MR slope is twice that of D curve for linear
demand curves
Summary of monopoly, part 2



Unregulated monopolies will set MB = MC to
maximize profit, leading to DWL
Monopolies are often controlled to prevent
substantial positive economic profits
Price discrimination and hurdles can reduce
inefficiencies of a monopolistic market
Introducing other kinds of
markets


We have now studied markets with one
seller and many sellers
We have yet to study other markets

Product-differentiated markets


Markets with close substitutes (Example:
Different brands of frosted-flake cereal)
Markets with a few sellers
Product-differentiated markets

An owner of a popular brand of cereal
has some market power over selling its
good


Firm can copyright the brand of cereal, a
form of market power
Demand may be flatly-sloped, due to
the substitutes available

Small increase in price may substantially
lower market share