Price Discrimination

Principles of
Microeconomics
Monopoly
In this chapter,
look for the answers to these questions:
Why do monopolies How do monopolies affect

arise? society’s well-being?
Why is MR < P for a What can the government

monopolist? do about monopolies?
How do monopolies What is price

choose their P and Q? discrimination?
Introduction
A monopoly is a firm that is the sole seller of a

product without close substitutes.
In this chapter, we study monopoly and contrast

it with perfect competition.
The key difference:
A monopoly firm has market power, the ability to
influence the market price of the product it sells.
A competitive firm has no market power.
Why Monopolies Arise
The main cause of monopolies is barriers
to entry – other firms cannot enter the market.
Three sources of barriers to entry:
2. The govt gives

1. A single firm a single firm the 3.
owns a key exclusive right to Natural monopoly:
resource. produce the a single firm can
good.
produce
E.g., DeBeers
the entire market
owns most of E.g., patents, Q at lower cost
the world’s copyright laws than could
diamond several firms.
mines
Monopoly vs.
Competition:
Demand Curves
In a competitive market, the market
demand curve slopes downward.
But the demand curve for any individual

firm’s product is horizontal at the
market price.
The firm can increase Q without

lowering P,
so MR = P for the
competitive firm.
Monopoly vs.
Competition:
Demand Curves
A monopolist is the only
seller, so it faces the
market demand curve.
To sell a larger Q,
the firm must reduce P.
Thus, MR ≠ P.
Understanding the
Monopolist’s MR Increasing Q has two
effects on revenue:
TR = P*Q
To sell a larger Q, the monopolist must
reduce the
price on all the units it sells.
Output effect: higher
Hence, MR < P output raises revenue
MR could even be negative if the price

effect Price effect: lower
exceeds the output effect (e.g., when price reduces
Common revenue
Grounds increases Q from 5 to 6).
Profit-Maximization
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The Welfare Cost of Monopoly
Recall: In a competitive market equilibrium,
P = MC and total surplus is maximized.
In the monopoly eq’m, P > MR = MC
The value to buyers of an additional unit (P)

exceeds the cost of the resources needed to
produce that unit (MC).
The monopoly Q is too low –

could increase total surplus with a larger Q.
Thus, monopoly results in a deadweight loss.

Price Competitive eq’m:
quantity = QC
P = MC
total surplus is
maximized
Monopoly eq’m:
quantity = QM
P > MC
deadweight loss
Price Discrimination
Discrimination: treating people
differently based on some
characteristic, e.g. race or gender.
Price discrimination: selling the
same good at different prices to
different buyers.
The characteristic used in price
discrimination is willingness to pay
(WTP):
A firm can increase profit by
charging a higher price to buyers
with higher WTP.
There are three lessons to be
learned about price discrimination.
The first and most The second lesson is that The third lesson from
obvious lesson is that price discrimination our parable is the most
price discrimination is a requires the ability to surprising: Price
rational strategy for a separate customers discrimination can raise
profit-maximizing according to their economic welfare
monopolist willingness to pay (WTP)
Price discrimination: A firm can increase
selling the same good at profit by charging a
different prices to higher price to buyers
different buyers. with higher WTP.
Perfect Price Discrimination vs.
Single Price Monopoly
Panel (a) shows a monopolist that charges the same price to

all customers. Total surplus in this market equals the sum of
profit (producer surplus) and consumer surplus
Here, the monopolist charges the same price (PM) to all

buyers. A deadweight loss results.
Perfect Price Discrimination vs.
Single Price Monopoly
Panel shows a monopolist that can perfectly price

discriminate. Because consumer surplus equals zero, total
surplus now equals the firm’s profit.
Here, the monopolist produces the competitive quantity, but

charges each buyer his or her WTP.
This is called perfect price discrimination.
The monopolist captures all CS as profit.
But there’s no DWL
Price Discrimination in the
Real World
In the real world, perfect price discrimination is
not possible:
No firm knows every buyer’s WTP
Buyers do not announce it to sellers
So, firms divide customers into groups based on
some observable trait that is likely related to
WTP, such as age
Examples of Price Discrimination
Movie tickets
Discounts for seniors, students, and people
who can attend during weekday afternoons.
They are all more likely to have lower WTP
than people who pay full price on Friday night.
Airline prices
Discounts for Saturday-night stayovers help
distinguish business travelers, who usually have
higher WTP, from more price-sensitive leisure
travelers.
Examples of Price Discrimination
Discount coupons
People who have time to clip and organize
coupons are more likely to have lower income and
lower WTP than others.
Need-based financial aid

Low income families have lower WTP for
their children’s college education.
Schools price-discriminate by offering
need-based aid to low income families.
Quantity discounts
A buyer’s WTP often declines with additional units,
so firms charge less per unit for large quantities
than small ones.
Example:A movie theater charges $4 for
a small popcorn and $5 for a large one that’s
twice as big.
Public Policy Toward Monopolies
Increasing competition with antitrust laws

Ban some anticompetitive practices, allow govt to break up
monopolies.
E.g., Sherman Antitrust Act (1890), Clayton Act (1914)
Regulation
Govt agencies set the monopolist’s price.
For natural monopolies, MC < ATC at all Q, so marginal cost pricing
would result in losses.
If so, regulators might subsidize the monopolist or set P = ATC for
zero economic profit.
Public Policy Toward Monopolies
Public ownership
Example: U.S. Postal Service
Problem: Public ownership is usually less efficient since no profit
motive to minimize costs
Doing nothing
The foregoing policies all have drawbacks, so the best policy may be
no policy.
Thank
you for
listening

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Principles of

Why do monopolies How do monopolies affect

Why is MR < P for a What can the government

How do monopolies What is price

A monopoly is a firm that is the sole seller of a

In this chapter, we study monopoly and contrast

2. The govt gives

But the demand curve for any individual

The firm can increase Q without

MR could even be negative if the price

Projects that inspire:

In the monopoly eq’m, P > MR = MC

The value to buyers of an additional unit (P)

The monopoly Q is too low –

Thus, monopoly results in a deadweight loss.

Panel (a) shows a monopolist that charges the same price to

Here, the monopolist charges the same price (PM) to all

Panel shows a monopolist that can perfectly price

Here, the monopolist produces the competitive quantity, but

Need-based financial aid

Increasing competition with antitrust laws

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