Instituto Tecnologico Autonomo de Mexico Licenciatura en Economa Microeconomics (Eco-11104) Indirect Discrimation & Monopsony

Second-degree price discrimination

Second-degree price discrimination involves charging dierent prices for different quantities or issuing two-part taris, it is a for of indirect discrimination. This you will note is also the source of the bulk-buying economies of scale discussed in the previous chapter on cost theory. A family pack of soap powder or biscuits tends to cost less per kg than smaller packs. This of course discriminates indirectly against people living alone, often pensioners and students. In some supermarkets the price per kg of product is listed, which helps the customer by providing information on which to base decisions on. Quantity discount, Two-part tari. Explain the idea of endogenously separating consumers (imperfectly).

1.1

Example

Two segmented markets with demands q1 = 24 q2 = 24 MC = 4 Solution q1 = 10 q2 = 8 = 132 1.1.1 p1 = 14 p2 = 8 CS = 56

1 2

p1 2p 2

M R1 = 24 M R2 = 12

2q1 q2

= 100 = 32

CS1 = 50 CS2 = 16 T S = 264

DW L1 = 50 DW L2 = 16

T S1 = 200 T S2 = 64

DW L = 66

Non-segmented markets: kinked demand 3p M R = 16 p = 10 CS = 98 + 4 = 102 1 DW L = 264 210 = 54 < 66 2 Q=4 3

Q = 48 Q = 18

= 108 < 132

you are on the correct side of the kink because on the other side you would sell only to one type of consumer and have a prot of
1

= 100 < 108

Note that if the market are not segmented the monopolist makes a smaller prot than with segmented markets. Note also that the DWL, that is the ine ciency, is smaller in the case of non-segmented markets (this is not true if the monopolist chooses to price above the kink). 1.1.2 Single two part tari Two part tari A: charge a price equal to the constant marginal cost (you ll make zero prot on that part of the tari) and on the other part of the tari charge a xed entry cost as high as both markets are willing to accept, that is, as high as the smallest consumer surplus of the two groups. (p = M C = 4; F = 64 = CS2 < CS1 ) = 2 (64) = 128 Two part tari B: p; F = (12 max p)2 = CS2 < CS1 p)2 + (p 4) ((24 p) + (24 2p)) = 12p p2 + 96

= 2 (12

Solution is (argmax and max): (p = 6; F = 36) Two part tari C (p = M C = 4; F = 200 = CS1 > CS2 ) = 200 whichi is the optimal tari as it gives the highest prot. In this tari only one type of consumers participates in the market and the other is left out. = 132

1.1.3

Two two part taris

Tari A and tari C can extract all the surplus if the markets are articially already segmented F1 = 200; F2 = 64; p1 = 4 p2 = 4

and generate the maximum prots possible, that is all the surplus goes to the monopolist as in rst degree price discrimination.

Natural Monopoly and Regulation

An industry is in the natural monopoly range if and only if its average cost is decreasing. For instance, if the total cost is C (q ) = 100 + q 2 then the average cost AC (q ) = 100 +q q

is decreasing up to its minimum which is reached at the cross with the marginal cost AC (q ) = M C (q ) 100 + q = 2q q q = arg min AC = 10 so in for q 2 [0; 10] this industry is in a Natural Monopoly. A Natural monopoly is "natural" because it is natural or more e cient to have only one rm in this industry, that produces at an e cient scale. Indeed, the natural monopoly is also a barrier to entry of other rms because the region where the AC drops is achieved for a high scale so it is not protable to have more than one rm in this industry. A regulator would permit a monopoly as long as it is natural, but would want to regulate it, namely to force to monopoly to charge at most some given price regulated pr . This price could be the perfectly competitive price pr = M C

but since the AC is decreasing we would have pr = M C < AC = q (pr AC ) < 0

and the rm would be suering losses. Another option is to let the rm charge its monopoly price up to a certain level and then after that level constrain the price to the marginal cost p = pm p = MC q q q>q

this way the rm would make a net prot overall (a gain on the rst units sold high and a loss on the last units sold low) if the q suitably chosen.

Monopsony

This happens when we have only one buyer. For instance, only one buyer (i.e. one hiring rm) in the labor market cannot be a wage taker, the rm faces the entire market supply curve and chooses optimally the wage it wants to pay its workers, taking into account their willingness to work or their cost of opportunity of working. To increase the hiring of labor one more unit the monopsonist must move higher on the supply curve which is of course increasing, this means that the monopolist needs to pay more not only the new worker but all the other ones too (in the absence of wage discrimination, of course). The marginal expense is the increase in the total cost of the labor input for the monopsonist that results from hiring one more unit of labor @w @wL =w+L >w M EL = @L @L since the supply is upward sloping this marginal expense is greater than the wage. At any price the rm wants to demand D = M RPL : The MRP (marginal revenue product (of labor in this case)) is the demand of the monopsonist as it is the "reservation price" of the rm, the maximum price the rm is willing to pay to hire a worker, that is how much the rm is going to produce times the price I can sell his output for. Hence, the maximization implies: Dem = M RPL = M EL =(like a marginal utility) The corresponding wage is lower than the competitive wage and the number of worker higher is also smaller. 4

Duality in Labor Markets MONOPOLY Exogenous Demand = Max Wage @ (LwD (L)) Marginal Revenue @L Marginal (Op.) Cost =Supp.= Res.. Wage MONOPSONY Exogenous Supply = Op. Cost of Leasure @ (LwS (L)) Marginal Expenditure @L Marginal Rev. Prod. = Dem.= Max Wage

Recall that ME is twice the linear Supply and MR is half the linear demand always. 3.0.4 Example

The rm is a coal mine where every coal worker can dig two tons q = 2 of coal that sells for p = 10 per ton. So the rm s demand for labor that is the maximum price she is willing to pay a worker is Dem = M RPL = 2(10) = 20 Labor supply assume is L = 50w L w = 50 @wL L M EL = = @L 25 Maximization implies: L = 20 25 L = 500 w = 10 Whereas the competitive wage would be higher of course (the monopsonist rm chooses a lower wage than in competition) 20 = L 50 L = 1000

w = 20

3.1

Monopsonist vs Labor Union

Labor unions face a free riding problem. Assume the same Labor supply: L = 50w L w = 50 @ (wL) L M EL = = @L 25 And downward sloping demand: Dem = M RPL = 70 L 10

which indeed is a decreasing marginal utility as usual. 1. MONOPSONY: This gives the same solution as before in the case of monopsony with demand Dem=20: M EL = M RPL L L = 70 25 10 L = 500 w = 10 2. COMPETITIVE SOLUTION: max (L) If the union can establish control over the labor supply, then other options become possible. The union could press for the competitive solution. This way the union wants to maximize L and so obtains the maximum employment of its members. No more hiring is possible in any other outcome:

L 50

= 70

L 10

L = w = 3. MONOPOLY:

1750 1 = 583 3 3 583 1 35 3 = = 11: 667 50 3 max (R C)

The union may want to maximize the economic rent of its workers: the total revenue minus the cost of working. This is basically a monopolist L supplier facing that demand: 70 10 , which implies: M R = 70 L 5 L = M OC = Supply 50 3500 L = = 318:18 11 3500 420 11 w = 70 = = 38:2 10 11 =

where the Supply of workers is the marginal opportunity cost MOC of the worker supply decision, the opportunity cost to have another guy work at that wage. That is the minimum price at which the additional worker is willing to work and forgo leisure. 7

4. MAXIMIZE TOTAL LABOR PAYMENTS: max (wL) Choose a point where total labor payments (wL) are maximized: MR = @ (wL) = 70 @L L = 350 L =0 5

w = 35 There can be an excess supply of labor at that wage. The three dierent outcome dier signicantly, so the real outcome depends crucial on which side has more market power.

3.2

Bilateral Monopoly

If both sides of the market are monopolized the outcome of the market is undetermined, and it depends on which side has the bargaining power.

So the outcome will be some wage in between the monopsony and the monopoly wage.