Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.
PART 5 Firm Behavior and the Organization of Industry
Chapter 15 of 32 - Monopoly
Section 21 of 31
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Actually, in many cases firms sell the same good to different customers for different prices.
This happens even though the costs of producing for the two customers are the same.
This practice is called price discrimination.
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Price discrimination is not possible when a good is sold in a competitive market.
Many firms are selling the same good at the same market price.
No firm is willing to charge a lower price to any consumer because the firm can sell at the market price and would be losing money because price is lower than cost.
If any firm tried to charge a higher price, consumers would buy from another firm.
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For a firm to price discriminate, it must have some market power, an ability to influence prices.
Imagine a company “Readmuch Publishing Company.”
One of Readmuch's best-selling authors has just completed a new novel.
Readmuch pays the author $2 million for the exclusive rights to publish the book, it now has a monopoly in the market for this book.
Because the book is to be sold only as an e-book, the cost of printing the book is zero.
Therefore, Readmuch's profit is the revenue from selling the book minus the $2 million paid to the author.
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How does Readmuch decide the book's price?
Its marketing department determines the book will attract two types of readers
· the author's 100,000 diehard fans who are willing to pay as much as $30
· about 400,000 others who will pay up to $5
If a single price to all customers is set, what price maximizes profit?
There are two prices to consider:
· $30 is the highest price Readmuch can charge and still get the 100,000 diehard fans
· $5 is the highest price it can charge and get the entire market of 500,000 potential readers
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Per Table A Case 1, at book price of $30
· Readmuch sells 100,000 copies
· sales revenue is $3 million
· cost is $2 million
· profit is $1 million
Per Case 2, at book price of $5
At price of $5
· Readmuch sells 500,000 copies
· sales revenue is $2.5 million
· cost is $2 million
· profit is $500,000
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Case 1 is more profitable, so Readmuch plans to charge $30 and thereby selling only to the diehard fans.
Readmuch's charging $30 will causes deadweight loss for the economy.
There are 400,000 more readers willing to pay $5 for the book.
Sales of 400,000 books x $5 = $2 million to non-diehard fans do not happen.
The marginal cost of providing the book to them is zero.
$2 million of total surplus will be lost.
This deadweight loss is the inefficiency that arises whenever a monopolist charges a price above marginal cost.
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The Readmuch marketing department also discovers these two groups of readers are in separate geographic markets
· the diehard fans live in Australia
· the other readers live in the United States
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In this case it is difficult for readers in one country to buy the book in the other because only two separate online services sell it, one in Australia and the other in the U.S.
So, Readmuch can change its marketing strategy and increase profits.
It can charge $30 for the book to the 100,000 Australian readers.
It can charge $5 for the book to the 400,000 American readers.
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Per Table A Case 3
Readmuch decides to implement this price discrimination, and sales revenue becomes
· $3 million in Australia
· $2 million in the United States
· for a total of revenue of $5 million
$5 million revenue - $2 million payment to the author = $3 million profit
This $3 million profit is substantially greater than what Readmuch could earn charging either $30 or $5 to all customers
As a result of the price discrimination the deadweight loss of $2 million in the market for this book is eliminated.
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This hypothetical case of Readmuch describes the business practice of many real-life publishing companies.
There is a substantial price difference between the initial high price hardcover edition and later low price paperback edition of the same book.
The price difference between these two editions is far greater than the difference in printing costs.
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hypothetical case
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