Chapter 11 Anggi

11
C H AP T E R
Pricing with
Market Power
Prepared by:
Fernando & Yvonn
Quijano
2008 Prentice Hall Business Publishing Microeconomics Pindyck/Rubinfeld, 7e.

CHAPTER 11 OUTLINE
11.1 Capturing Consumer Surplus
11.2 Price Discrimination
11.3 Intertemporal Price Discrimination and Peak-

Chapter 11: Pricing with Market Power
Load Pricing
11.4 The Two-Part Tariff
11.5 Bundling
11.6 Advertising
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Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall Microeconomics Pindyck/Rubinfeld, 7e.
11.1 CAPTURING CONSUMER SURPLUS
One common thing in pricing strategies : They are means to

capturing consumer surplus and transferring it to the producer
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

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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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.
Additional Profit from Perfect First-Degree

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
firms 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.
If we add up the profit on each incremental unit, we obtain variable

profit (Sum of profits on each incremental unit produced by a firm; i.e.,
profit ignoring fixed costs.)
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First-Degree Price Discrimination

Perfect Price Discrimination
What happens if firm can perfectly discriminate ?
The additional profit from producing and selling an incremental unit is now the
difference between demand and marginal cost.
Imperfect Price Discrimination

First-Degree Price Discrimination in

Practice
Perfect first degree price
discrimination is almost never
possible.
Here, six different prices are

charged. The firm earns higher
profits, but some consumers
may also benefit.
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Second-Degree Price Discrimination

second-degree price discrimination : Practice of charging different prices per unit for
different quantities of the same good or service. Example : Quantity Discount
$5 5 for $14
Another example of second degree of discrimination block pricing Practice of

charging different prices for different quantities or blocks of a good.
Example : electric power companies, natural gas utilities
Second-Degree Price Discrimination
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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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 .
Product Name : Rising Crown Product Name : Oldie Goodie

Price : $16 Price : $8
Creating Consumer Groups

If third-degree price discrimination is feasible, how should the firm decide 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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Creating Consumer Groups
(Total Profit)
Marginal revenue must be

equal across the group of

consumer and must be equal
marginal cost
(11.1)
Determining Relative Prices
(11.2)
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Determining Relative Prices
Figure 11.6
No Sales to Smaller Market
Even if third-degree price discrimination

is feasible, it may not pay to sell to both
groups of consumers if marginal cost is
rising.
Here the first group of consumers, with

demand D1, are not willing to pay much
for the product.
It is unprofitable to sell to them because

the price would have to be too low to
compensate for the resulting increase in
marginal cost.
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Coupons provide a means of price

discrimination.
Why do firms issue these coupons
rather than reduce the price and
save printing and collecting
coupons
Studies show that only about 20 to

30 percent of all consumers
regularly bother to clip, save, and
use coupons
They have more price elastic
demand and lower reservation
price
Only those consumers with
relatively price-sensitive demands
bother to send in the materials and
request rebates.
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TABLE 11.1 Price Elasticities of Demand for Users versus

Nonusers of Coupons
PRICE ELASTICITY
Product Nonusers Users
Toilet tissue 0.60 0.66
Stuffing/dressing 0.71 0.96

Shampoo 0.84 1.04
Cooking/salad oil 1.22 1.32
Dry mix dinners 0.88 1.09
Cake mix 0.21 0.43
Cat food 0.49 1.13
Frozen entrees 0.60 0.95
Gelatin 0.97 1.25
Spaghetti sauce 1.65 1.81
Creme rinse/conditioner 0.82 1.12
Soups 1.05 1.22
Hot dogs 0.59 0.77
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11.3 INTERTEMPORAL PRICE DISCRIMINATION
AND PEAK-LOAD PRICING
intertemporal price discrimination Practice

of separating consumers with different demand
functions into different groups by charging
different prices at different points in time.
peak-load pricing Practice of charging higher

prices during peak periods when capacity
constraints cause marginal costs to be high.
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Intertemporal Price Discrimination
Objective : to divide consumers into high demand and low demand groups by
charging a price that is high at first but falls later
Figure 11.7
Intertemporal Price Discrimination

D1 : inelastic demand curve for small
grup consumer who value the product
highly and dont buy.
D2 : group of consumer more willing to

forgo if the price is too high
Strategy :
P1 sell to D1
Reduce the price to P2 and sales are
made to larger group in group D2 (mass
market)
Example : First run movie
.
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Peak-Load Pricing
Also involves charging different prices at different point in time.
Objective : to increase economic efficiency by charging consumer prices that are
close to marginal cost
Peak Period High

Marginal cost (Capacity
Constraints)
Figure 11.8
Peak-Load Pricing
D1 is peak period pricing at P1

Charging a higher price P1
during the peak periods is more
profitable for the firm than
charging a single price at all
times.
It is also more efficient because

marginal cost is higher during
peak periods.
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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
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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11

2008 Prentice Hall Business Publishing Microeconomics Pindyck/Rubinfeld, 7e.

11.1 Capturing Consumer Surplus

11.2 Price Discrimination

11.3 Intertemporal Price Discrimination and Peak-

11.4 The Two-Part Tariff

One common thing in pricing strategies : They are means to

Capturing Consumer Surplus

pay more than P*, thereby capturing

price discrimination : Practice of charging different prices to different

First-Degree Price Discrimination

Additional Profit from Perfect First-Degree

Because the firm charges each consumer her

If we add up the profit on each incremental unit, we obtain variable

First-Degree Price Discrimination

Imperfect Price Discrimination

First-Degree Price Discrimination in

Here, six different prices are

Second-Degree Price Discrimination

Another example of second degree of discrimination block pricing Practice of

Second-Degree Price Discrimination

There are also economies of

Third-Degree Price Discrimination

Product Name : Rising Crown Product Name : Oldie Goodie

Creating Consumer Groups

Third-Degree Price Discrimination

Marginal revenue must be

equal across the group of

Determining Relative Prices

Third-Degree Price Discrimination

No Sales to Smaller Market

Even if third-degree price discrimination

Here the first group of consumers, with

It is unprofitable to sell to them because

Coupons provide a means of price

Studies show that only about 20 to

TABLE 11.1 Price Elasticities of Demand for Users versus

Stuffing/dressing 0.71 0.96

intertemporal price discrimination Practice

peak-load pricing Practice of charging higher

Intertemporal Price Discrimination

highly and dont buy.

D2 : group of consumer more willing to

Peak Period High

D1 is peak period pricing at P1

It is also more efficient because

Publishing both hardbound and paperback

the price is $25. Other consumers, however,

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