Chapter 11

Chapter 11
Pricing with
Market Power
Topics to be Discussed
 Capturing Consumer Surplus

 Price Discrimination
 Intertemporal Price Discrimination and
Peak-Load Pricing
Chapter 11 Slide 2
Topics to be Discussed
 The Two-Part Tariff

 Bundling
 Advertising
Chapter 11 Slide 3
Introduction
 Pricing without market power (perfect

competition) is determined by market
supply and demand.
 The individual producer must be able to
forecast the market and then
concentrate on managing production
(cost) to maximize profits.
Chapter 11 Slide 4
Introduction
 Pricing with market power (imperfect

competition) requires the individual
producer to know much more about the
characteristics of demand as well as
manage production.
Chapter 11 Slide 5
Capturing Consumer Surplus
Between 0 and Q*, consumers
will pay more than
$/Q Pmax A P*--consumer surplus (A).
P1
PC is the price
that would exist in
P* B a perfectly competitive
market.
P2
MC If price is raised above
PC P*, the firm will lose
sales and reduce profit.
D
Beyond Q*, price will
have to fall to create a
consumer surplus (B).
MR
Q* Quantity
Chapter 11 Slide 6
$/Q Pmax A
•P*Q*: single P & Q @ MC=MR P1
•A: consumer surplus with P*
•B: P>MC & consumer would buy P* B
at a lower price
P2
•P1: less sales and profits
•P2 : increase sales & and reduce MC
PC
revenue and profits
•PC: competitive price
D
MR
Q* Quantity
Chapter 11 Slide 7
Question
$/Q Pmax A How can the firm
capture the consumer surplus
P1 in A and sell profitably in B?
P* B
Answer
P2 Price discrimination
Two-part tariffs
MC
PC Bundling
MR
Q* Quantity
Chapter 11 Slide 8
 Price discrimination is the charging of

different prices to different consumers
for similar goods.
Chapter 11 Slide 9
Price Discrimination
 First Degree Price Discrimination

 Charge a separate price to each customer:
the maximum or reservation price they are
willing to pay.
Chapter 11 Slide 10
Additional Profit From Perfect First-
Degree Price Discrimination
Without price discrimination,
output is Q* and price is P*.
$/Q Pmax Variable profit is the area
between the MC & MR (yellow). Consumer surplus is the area
above P* and between
0 and Q* output.
MC
P*
With perfect discrimination, each
consumer pays the maximum
PC price they are willing to pay.
D = AR
Output expands to Q** and price
falls to PC where MC = MR = AR = D.
Profits increase by the area above MC
between old MR and D to output
MR Q** (purple)
Q* Q** Quantity
Chapter 11 Slide 11
With perfect discrimination
• Each customer pays their
reservation price
$/Q Pmax Consumer surplus when a •Profits increase
single price P* is charged.
Variable profit when a
single price P* is charged.
MC
P*
Additional profit from
perfect price discrimination
PC
D = AR
MR
Q* Q** Quantity
Chapter 11 Slide 12
 Question
 Why would a producer have difficulty in
achieving first-degree price discrimination?
 Answer
1) Too many customers (impractical)
2) Could not estimate the reservation
price for each customer
Chapter 11 Slide 13

 The model does demonstrate the potential
profit (incentive) of practicing price
discrimination to some degree.
Chapter 11 Slide 14

 Examples of imperfect price discrimination
where the seller has the ability to segregate
the market to some extent and charge
different prices for the same product:
 Lawyers, doctors, accountants
 Car salesperson (15% profit margin)

 Colleges and universities
Chapter 11 Slide 15
First-Degree Price
Discrimination in Practice
Six prices exist resulting

$/Q in higher profits. With a single price
P1 P*4, there are few consumers and
those who pay P5 or P6 may have a surplus.
P2
P3
P*4 MC
P5
P6
MR
Q Quantity
Chapter 11 Slide 16
Second-Degree Price Discrimination
Second-degree price
discrimination is pricing
$/Q according to quantity
consumed--or in blocks.
P1
Without discrimination: P = P0
P0 and Q = Q0. With second-degree
discrimination there are three
prices P1, P2, and P3.
(e.g. electric utilities)
P2
AC
P3 MC
MR
Q1 Q0 Q2 Q3 Quantity
1st Block 2nd Block 3rd Block

Second-Degree Price Discrimination
$/Q
Economies of scale permit:
P1
•Increase consumer welfare
P0 •Higher profits
P2
AC
P3 MC
MR
Q1 Q0 Q2 Q3 Quantity
1st Block 2nd Block 3rd Block

 Third Degree Price Discrimination
1) Divides the market into two-

groups.
2) Each group has its own demand

function.
Chapter 11 Slide 19
3) Most common type of price

discrimination.
 Examples: airlines, liquor, vegetables,
discounts to students and senior
citizens.
Chapter 11 Slide 20
4) Third-degree price discrimination is

feasible when the seller can separate
his/her market into groups who have
different price elasticities of demand (e.g.
business air travelers versus vacation
air travelers)
Chapter 11 Slide 21

 Objectives
 MR1 = MR2
 MC1 = MR1 and MC2 = MR2
 MR1 = MR2 = MC
Chapter 11 Slide 22

 P1: price first group
 P2: price second group
 C(Qr) = total cost of QT = Q1 + Q2

 Profit ( ) = P Q + P2Q2 - C(Qr)
1 1
Chapter 11 Slide 23

 Set incremental  for sales to group 1 = 0
  ( P1Q1) C
   0
Q1 Q1 Q1
 ( P1Q1 ) C
  MR1   MC
Q1 Q1
Chapter 11 Slide 24

 Second group of customers: MR2 = MC
 MR1 = MR2 = MC
Chapter 11 Slide 25

 Determining relative prices
Recall : MR  P1  1 Ed 

Then : MR1  P1 (1  1 E1 )  MR2  P2 (1  1 E2 )
Chapter 11 Slide 26

 Determining relative prices
P1 (1  1 E2 )
 And : 
P2 (1  1 E1 )
 Pricing: Charge higher price to group with

a low demand elasticity
Chapter 11 Slide 27

 Example: E1 = -2 & E2 = -4
P1 (1  1 4)
   3 4 1 2  1.5
P2 (1  1 2)
 P1 should be 1.5 times as high as P2
Chapter 11 Slide 28
Third-Degree Price Discrimination
$/Q Consumers are divided into
two groups, with separate
demand curves for each group.
MRT = MR1 + MR2
D2 = AR2
MRT
MR2
MR1 D1 = AR1
Quantity
Chapter 11 Slide 29
Third-Degree Price Discrimination
$/Q MC = MR1 at Q1 and P1
•QT: MC = MRT
•Group 1: P1Q1 ; more elastic
P1 •Group 2: P2Q2; more inelastic
•MR1 = MR2 = MC
•QT control MC
MC
P2
D2 = AR2
MRT
MR2
MR1 D1 = AR1
Q1 Q2 QT Quantity
Chapter 11 Slide 30
No Sales to Smaller Market
Even if third-degree price

discrimination is feasible, it doesn’t
always pay to sell to both groups
of consumers if marginal cost is rising.
Chapter 11 Slide 31
No Sales to Smaller Market
Group one, with
$/Q
demand D1, are not
willing to pay enough
MC for the good to
make price
P* discrimination profitable.
D2
MR2
D1
MR1 Q* Quantity
Chapter 11 Slide 32
The Economics of Coupons and Rebates
 Those consumers who are more price

elastic will tend to use the coupon/rebate
more often when they purchase the
product than those consumers with a less
elastic demand.
 Coupons and rebate programs allow firms
to price discriminate.
Chapter 11 Slide 33
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 dinner -0.88 -1.09
Cake mix -0.21 -0.43
Chapter 11 Slide 34
Price Elasticities of Demand for Users
Versus Nonusers of Coupons
Price Elasticity
Product Nonusers Users
Cat food -0.49 -1.13
Frozen entrée -0.60 -0.95
Gelatin -0.97 -1.25
Spaghetti sauce -1.65 -1.81
Crème rinse/conditioner -0.82 -1.12
Soup -1.05 -1.22
Hot dogs -0.59 -0.77
Chapter 11 Slide 35
 Cake Mix
 Nonusers of coupons: PE = -0.21
 Users: PE = -0.43
Chapter 11 Slide 36
 Cake Mix Brand (Pillsbury)

 PE: 8 to 10 times cake mix PE
 Example
 PE Users: -4
 PE Nonusers: -2
Chapter 11 Slide 37
P1 (1  1 E2 )
 Using: 
P2 (1  1 E1 )
 Price of nonusers should be 1.5 times

users
 Or, if cake mix sells for $1.50, coupons
should be 50 cents
Chapter 11 Slide 38
Airline Fares
 Differences in elasticities imply that

some customers will pay a higher fare
than others.
 Business travelers have few choices
and their demand is less elastic.
 Casual travelers have choices and are
more price sensitive.
Chapter 11 Slide 39
Elasticities of
Demand for Air Travel
Fare Category
Elasticity First-Class Unrestricted Coach Discount
Price -0.3 -0.4 -0.9
Income 1.2 1.2 1.8
Chapter 11 Slide 40
Airline Fares
 The airlines separate the market by

setting various restrictions on the
tickets.
 Less expensive: notice, stay over the
weekend, no refund
 Most expensive: no restrictions
Chapter 11 Slide 41
Intertemporal Price
Discrimination and Peak-Load Pricing
 Separating the Market With Time

 Initial release of a product, the demand is
inelastic
 Book
 Movie
 Computer
Chapter 11 Slide 42
Intertemporal Price
 Separating the Market With Time

 Once this market has yielded a maximum
profit, firms lower the price to appeal to a
general market with a more elastic demand
 Paper back books
 Dollar Movies
 Discount computers
Chapter 11 Slide 43
Intertemporal Price Discrimination
Consumers are divided
$/Q into groups over time.
Initially, demand is less
P1 elastic resulting in a
price of P1 . Over time, demand becomes
more elastic and price
is reduced to appeal to the
mass market.
P2
D2 = AR2
AC = MC
MR2
MR1 D1 = AR1
Q1 Q2 Quantity
Chapter 11 Slide 44
Intertemporal Price
Peak-Load Pricing
 Demand for some products may peak at

particular times.
 Rush hour traffic
 Electricity - late summer afternoons
 Ski resorts on weekends
Chapter 11 Slide 45
Intertemporal Price
Peak-Load Pricing
 Capacity restraints will also increase

MC.
 Increased MR and MC would indicate a
higher price.
Chapter 11 Slide 46
Intertemporal Price
Peak-Load Pricing
 MR is not equal for each market

because one market does not impact
the other market.
Chapter 11 Slide 47
Peak-Load Pricing
$/Q MC
Peak-load
price = P1 .
P1
D1 = AR1
Off- load
price = P2 . P2
MR1
D2 = AR2
MR2
Q2 Q1 Quantity
Chapter 11 Slide 48
How to Price a Best Selling Novel
 What Do You Think?
1) How would you arrive at the price

for the initial release of the hardbound
edition of a book?
Chapter 11 Slide 49
2) How long do you wait to release

the paperback edition? Could the
popularity of the book impact
your decision?
Chapter 11 Slide 50
3) How do you determine the price for

the paperback edition?
Chapter 11 Slide 51
The Two-Part Tariff
 The purchase of some products and

services can be separated into two
decisions, and therefore, two prices.
Chapter 11 Slide 52
The Two-Part Tariff
 Examples
1) Amusement Park
 Pay to enter
 Pay for rides and food within the park
2) Tennis Club
 Pay to join
 Pay to play
Chapter 11 Slide 53
The Two-Part Tariff
 Examples
3) Rental of Mainframe Computers
 Flat Fee
 Processing Time
4) Safety Razor
 Pay for razor
 Pay for blades
Chapter 11 Slide 54
The Two-Part Tariff
 Examples
5) Polaroid Film
 Pay for the camera
 Pay for the film
Chapter 11 Slide 55
The Two-Part Tariff
 Pricing decision is setting the entry

fee (T) and the usage fee (P).
 Choosing the trade-off between free-
entry and high use prices or high-entry
and zero use prices.
Chapter 11 Slide 56
Two-Part Tariff with a Single Consumer
$/Q
Usage price P*is set where
MC = D. Entry price T*
T* is equal to the entire
consumer surplus.
MC
P*
Quantity
Chapter 11 Slide 57
Two-Part Tariff with Two Consumers
The price, P*, will be
$/Q greater than MC. Set T*
T* at the surplus value of D2.
A   2T *  ( P*  MC ) x(Q1  Q2 )
 more than twice ABC
MC
B
C D1 = consumer 1
D2 = consumer 2
Q2 Q1 Quantity
Chapter 11 Slide 58
The Two-Part Tariff
 The Two-Part Tariff With Many Different

Consumers
 No exact way to determine P* and T*.
 Must consider the trade-off between the
entry fee T* and the use fee P*.
 Low entry fee: High sales and falling
profit with lower price and more entrants.
Chapter 11 Slide 59
The Two-Part Tariff
 The Two-Part Tariff With Many Different

Consumers
 To find optimum combination, choose
several combinations of P,T.
 Choose the combination that maximizes
profit.
Chapter 11 Slide 60
Two-Part Tariff with
Many Different Consumers
Profit    a   s  n(T )T  ( P  MC )Q(n)

n  entrants
Total profit is the sum of the

profit from the entry fee and
the profit from sales. Both
depend on T.
 Total
 a :entry fee
 s:sales
T* T
Chapter 11 Slide 61
The Two-Part Tariff
 Rule of Thumb
 Similar demand: Choose P close to MC
and high T
 Dissimilar demand: Choose high P and low
T.
Chapter 11 Slide 62
The Two-Part Tariff
 Two-Part Tariff With A Twist

 Entry price (T) entitles the buyer to a
certain number of free units
 Gillette razors with several blades
 Amusement parks with some tokens
 On-line with free time
Chapter 11 Slide 63
Polaroid Cameras
 1971 Polaroid introduced the SX-70

camera
 How would you price the camera and film?
Chapter 11 Slide 64
Polaroid Cameras
 Hint
  PQ  nT  C1 (Q)  C2 (n)
P  price of film
T  price of camera
Q  quantity of film sold
n  number of cameras sold
C1 (Q)  cost of producing film
C2 (n)  cost of producing cameras
Chapter 11 Slide 65
Pricing Cellular Phone Service
 Question
 Why do cellular phone providers offer
several different plans instead of a single
two-part tariff with an access fee and per-
unit charge?
Chapter 11 Slide 66
Bundling
 Bundling is packaging two or more

products to gain a pricing advantage.
 Conditions necessary for bundling
 Heterogeneous customers
 Price discrimination is not possible
 Demands must be negatively correlated
Chapter 11 Slide 67
Bundling
 An example: Leasing “Gone with the

Wind” & “Getting Gerties Garter.”
 The reservation prices for each theater and
movie are:
Gone with the Wind Getting Gertie’s Garter
Theater A $12,000 $3,000

Theater B $10,000 $4,000
Chapter 11 Slide 68
Bundling
 Renting the movies separately would

result in each theater paying the lowest
reservation price for each movie:
 Maximum price Wind = $10,000
 Maximum price Gertie = $3,000
 Total Revenue = $26,000
Chapter 11 Slide 69
Bundling
 If the movies are bundled:

 Theater A will pay $15,000 for both
 Theater B will pay $14,000 for both
 If each were charged the lower of the

two prices, total revenue will be
$28,000.
Chapter 11 Slide 70
Bundling
Relative Valuations
 Negative Correlated: Profitable to
Bundle
A pays more for Wind ($12,000) than B
($10,000).
B pays more for Gertie ($4,000) than A
($3,000).
Chapter 11 Slide 71
Bundling
Relative Valuations
 If the demands were positively

correlated (Theater A would pay more
for both films as shown) bundling would
not result in an increase in revenue.
Gone with the Wind Getting Gertie’s Garter
Theater A $12,000 $4,000

Theater B $10,000 $3,000
Chapter 11 Slide 72
Bundling
 If the movies are bundled:

 Theater A will pay $16,000 for both
 Theater B will pay $13,000 for both
 If each were charged the lower of the

two prices, total revenue will be
$26,000, the same as by selling the
films separately.
Chapter 11 Slide 73
Bundling
 Bundling Scenario: Two different goods

and many consumers
 Many consumers with different reservation
price combinations for two goods
Chapter 11 Slide 74
Reservation Prices
r2
(reservation Consumer
price Good 2) C
$10
Consumer A is
willing to pay up to
$3.25 for good 1 and
Consumer up to $6 for good 2.
A
$6
$5 Consumer
B
$3.25
r1
(reservation price
$3.25 $5 $8.25 $10 Good 1)
Chapter 11 Slide 75
Consumption Decisions When
Products are Sold Separately
r2 R1  P1 R1  P1 Consumers fall into

four categories based
R2  P2 R2  P2 on their reservation
price.
II I
Consumers buy Consumers buy
only good 2 both goods
P2
R1  P1 R1  P1
R2  P2 R2  P2
III IV
Consumers buy Consumers buy
neither good only Good 1
P1 r1
Chapter 11 Slide 76
Consumption Decisions
When Products are Bundled
Consumers buy the bundle

r2 when r1 + r2 > PB
(PB = bundle price).
I PB = r1 + r2 or r2 = PB - r1
Region 1: r > PB
Consumers Region 2: r < PB
buy bundle
(r > PB)
r2 = PB - r1
II
Consumers do
not buy bundle
(r < PB)
r1
Chapter 11 Slide 77
Consumption Decisions
When Products are Bundled
 The effectiveness of bundling depends

upon the degree of negative correlation
between the two demands.
Chapter 11 Slide 78
Reservation Prices
r2 If the demands are
perfectly positively
correlated, the firm
will not gain by bundling.
It would earn the same
profit by selling the
goods separately.
P2
P1 r1
Chapter 11 Slide 79
Reservation Prices
r2 If the demands are
perfectly negatively
correlated bundling is the
ideal strategy--all the
consumer surplus can
be extracted and a higher
profit results.
r1
Chapter 11 Slide 80
Movie Example
(Gertie) r2
10,000 Bundling pays due to

negative correlation
5,000 B
4,000
A
3,000
5,000 10,000 12,000 14,000 r1

Chapter 11 (Wind)
Slide 81
Bundling
 Mixed Bundling
 Selling both as a bundle and separately
 Pure Bundling
 Selling only a package
Chapter 11 Slide 82
Mixed Versus Pure Bundling
C1 = MC1
r2 With positive marginal
C1 = 20 costs, mixed bundling
100 A
may be more profitable
90 than pure bundling.
80
Consumer A, for example, has
70 a reservation price for good 1
that is below marginal cost c1.
60 With mixed bundling, consumer A
B is induced to buy only good 2, while
50 consumer D is induced to buy only good 1,
C reducing the firm’s cost.
40
30 C2 = MC2
20 C2 = 30
D
10
10 20 30 40 50 60 70 80 90 100 r1
Chapter 11 Slide 83
Bundling
Mixed vs. Pure Bundling
 Scenario
 Perfect negative correlation
 Significant marginal cost
Chapter 11 Slide 84
Bundling
Mixed vs. Pure Bundling
 Observations
 Reservation price is below MC for some
consumers
 Mixed bundling induces the consumers to buy only
goods for which their reservation price is greater
than MC
Chapter 11 Slide 85
Bundling Example
 Sell Separately
 Consumers B,C, and D buy 1 and A buys 2
 Pure Bundling
 Consumers A, B, C, and D buy the bundle
 Mixed Bundling
 Consumer D buys 1, A buys 2, and B & C buys
the bundle
Chapter 11 Slide 86
Bundling Example
P1 P2 PB Profit
Sell separately $50 $90 ---- $150
Pure bundling ---- ---- $100 $200
Mixed bundling $89.95 $89.95 $100 $229.90
C1 = $20
C2 = $30
Chapter 11 Slide 87
Bundling
 Sell Separately
 3($50 - $20) + 1($90 - $30) = $150
 Pure Bundling
 4($100 - $20 - $30) = $200
 Mixed Bundling
 ($89.95 - $20) + ($89.95 - $30) - 2($100 - $20 - $30) =
$229.90
 C1 = $20 C2 = $30
Chapter 11 Slide 88
Bundling
 Question
 If MC = 0, would mixed bundling still be the
most profitable strategy with perfect
negative correlation?
Chapter 11 Slide 89
Mixed Bundling
with Zero Marginal Costs
r2 120
In this example, consumers B and C

100 are willing to pay $20 more for the bundle
A than are consumers A and D. With
90 mixed bundling, the price of the bundle
B
can be increased to $120.
80 A & D can be charged $90 for a single good.
60
C
40
20
10 D
10 20 40 60 80 90 100 120
r1
Chapter 11 Slide 90
Mixed Bundling
with Zero Marginal Costs
P1 P2 PB Profit
Sell separately $80 $80 ---- $320
Pure bundling ---- ---- $100 $400
Mixed bundling $90 $90 $120 $420
Chapter 11 Slide 91
Bundling
 Question
 Why is mixed bundling more profitable with
MC = 0?
Chapter 11 Slide 92
Bundling
 Bundling in Practice
 Automobile option packages
 Vacation travel
 Cable television
Chapter 11 Slide 93
Bundling
 Mixed Bundling in Practice

 Use of market surveys to determine
reservation prices
 Design a pricing strategy from the survey
results
Chapter 11 Slide 94
Mixed Bundling in Practice
r2
The dots are estimates of
PB reservation prices for a
representative sample of consumers.
P2 The firm can first choose a price

for the bundle and then try individual
prices P1 and P2 until total profit
is roughly maximized.
P1 PB r1
Chapter 11 Slide 95
The Complete Dinner Versus a la Carte:
A Restaurant’s Pricing Problem
 Pricing to match consumer preferences

for various selections
 Mixed bundling allows the customer to
get maximum utility from a given
expenditure by allowing a greater
number of choices.
Chapter 11 Slide 96
Bundling
 Tying
 Practice of requiring a customer to
purchase one good in order to purchase
another.
 Examples
 Xerox machines and the paper
 IBM mainframe and computer cards
Chapter 11 Slide 97
Bundling
 Tying
 Allows the seller to meter the customer and
use a two-part tariff to discriminate against
the heavy user
 McDonald’s
 Allows them to protect their brand name.
Chapter 11 Slide 98
Advertising
 Assumptions
 Firm sets only one price
 Firm knows Q(P,A)
 How quantity demanded depends on
price and advertising
Chapter 11 Slide 99
Effects of Advertising If the firm advertises,
its average and marginal
AR and MR are average revenue curves shift to
and marginal revenue when the right -- average costs
the firm doesn’t advertise. rise, but marginal cost
$/Q 1 does not.
MC
P1
AR’
AC’
P0 AC
0 MR’
AR
MR
Q0 Q1 Quantity
Chapter 11 Slide 100

Advertising
 Choosing Price and Advertising

Expenditure
  PQ( P, A)  C (Q)  A
Q Q
MRAds  P  1  MC  full MC of adv.
A A

Advertising
 A Rule of Thumb for Advertising
( P  MC ) / P  1 / E P for pricing
Q
( P-MC ) 1
A
P  MC  A Q  A
    Adv. to sales ratio
P  Q A  PQ

Advertising
( A Q)(Q A)  E A  Adv. elasticity of demand

( P  MC ) P   1 EP
A PQ  ( E A E P )  Rule of Thumb

Advertising

 To maximize profit, the firm’s
advertising-to-sales ratio should be
equal to minus the ratio of the
advertising and price elasticities of
demand.

Advertising
 An Example
 R(Q) = $1 million/yr
 $10,000 budget for A (advertising--1% of
revenues)
 EA = .2 (increase budget $20,000, sales
increase by 20%
 EP = -4 (markup price over MC is substantial)

Advertising
 Question
 Should the firm increase advertising?

Advertising
 YES
 A/PQ = -(2/-.4) = 5%
 Increase budget to $50,000

Advertising
 Questions
 When EA is large, do you advertise more or
less?
 When EP is large, do you advertise more or
less?

Advertising
 Advertising: In Practice
 Estimate the level of advertising for each of
the firms
 Supermarkets ( EP  10; E A  0.1 to 0.3)
 Convenience stores ( EP  5; E A  very small)
 Designer jeans ( EP  3 to  4; E A  .3 to 1)
 Laundry detergents ( EP  3 to  4;
E A  very large)

Summary
 Firms with market power are in an enviable

position because they have the potential to
earn large profits, but realizing that potential
may depend critically on the firm’s pricing
strategy.
 A pricing strategy aims to enlarge the
customer base that the firm can sell to, and
capture as much consumer surplus as
possible.

Summary
 Ideally, the firm would like to perfectly

price discriminate.
 The two-part tariff is another means of
capturing consumer surplus.
 When demands are heterogeneous and
negatively correlated, bundling can
increase profits.

Summary
 Bundling is a special case of tying, a

requirement that products be bought or
sold in some combination.
 Advertising can further increase profits.

End of Chapter 11
Pricing with
Market Power

Chapter 11

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Chapter 11

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Chapter 11

 Capturing Consumer Surplus

 The Two-Part Tariff

 Pricing without market power (perfect

 Pricing with market power (imperfect

 Price discrimination is the charging of

 First Degree Price Discrimination

 First Degree Price Discrimination

 First Degree Price Discrimination

 Car salesperson (15% profit margin)

Six prices exist resulting

1st Block 2nd Block 3rd Block

1st Block 2nd Block 3rd Block

 Third Degree Price Discrimination

1) Divides the market into two-

2) Each group has its own demand

 Third Degree Price Discrimination

3) Most common type of price

 Third Degree Price Discrimination

4) Third-degree price discrimination is

 Third Degree Price Discrimination

 Third Degree Price Discrimination

 Third Degree Price Discrimination

 Third Degree Price Discrimination

 Third Degree Price Discrimination

 Third Degree Price Discrimination

 Pricing: Charge higher price to group with

 Third Degree Price Discrimination

 P1 should be 1.5 times as high as P2

MRT = MR1 + MR2

Even if third-degree price

 Those consumers who are more price

 Cake Mix Brand (Pillsbury)

 Price of nonusers should be 1.5 times

 Differences in elasticities imply that

Price -0.3 -0.4 -0.9

Income 1.2 1.2 1.8

 The airlines separate the market by

 Separating the Market With Time

 Separating the Market With Time

 Demand for some products may peak at

 Capacity restraints will also increase

 MR is not equal for each market

 What Do You Think?

1) How would you arrive at the price

 What Do You Think?

2) How long do you wait to release

 What Do You Think?

3) How do you determine the price for

 The purchase of some products and

 Pricing decision is setting the entry

 The Two-Part Tariff With Many Different

 The Two-Part Tariff With Many Different

Profit    a   s  n(T )T  ( P  MC )Q(n)

Total profit is the sum of the

 Two-Part Tariff With A Twist

 1971 Polaroid introduced the SX-70

 Bundling is packaging two or more

 An example: Leasing “Gone with the

Theater A $12,000 $3,000

 Renting the movies separately would

 Total Revenue = $26,000

 If the movies are bundled: