Mass Market Pricing

1
Mass Market Pricing

• How to price to markets with large numbers of
  consumers

2
Looking forward ...

• Concept of mass market demand
• Relationship between revenue and demand
• Profit maximising price levels
• Concept of elasticity
• Innovative pricing

3
Playing games with consumers
(High Margin, Low Consumer Surplus)
Buy
Consumer
Not
(0, 0)
Firm
Choose Price (same for all)
(Low Margin, High Consumer Surplus)
Buy
Consumer
Not
(0, 0)
4
Roll back
Few sales with high margins
Firm
Choose Price (same for all)
Lots of sales with low margins
5
Posted prices versus negotiation

• In mass markets, only price-posting may be
  feasible
• ? Its like making a take-it-or-leave-it offer!
• Consumers whose WTP gt p purchase from you
• If all consumers WTPs equal, can extract all the
  surplus
• But, if WTPs are different, same p ? cant
  extract all the surplus

6
When is price-posting reasonable?

• Price haggling too costly relative to value of
  product
• Large numbers of customers ? bargaining is
  inefficient
• Information requirements too demanding
• Do you know buyers WTP, in a big anonymous
  market?
• Markets are perfectly competitive
• Bargaining not an issue anyway
• Price-posting should be efficient
• Usually, firms post (set) prices

7
Puzzle Luxury Boxes

• Among the many decisions made by sports stadium
  designers is the number of luxury boxes to build
• Suppose that, for a particular stadium under
  construction, luxury boxes will be sold outright
  to local businesses and can be constructed at a
  cost of 300,000 apiece. The stadium designer
  plans to build 25 boxes and expects, at this
  number, to sell each for 1 million, for a net
  profit of 700,000 x 25 17.5m.
• An associate asserts that this is crazy. Since
  the box can be built for 300,000 and sold for
  around 1m apiece, building only 25 leaves money
  on the table, even if a small price reduction is
  needed if more are built.
• Is the associate correct? What if the price to
  sell 26 is 950,000?

8
Demand curves

• In mass markets, relevant consumer information
  summarised by a demand curve
• A demand curve identifies how many units of
  product sell at any posted price
• The market demand curve is derived from the WTPs
  of all potential consumers

9
Numerical Example

• 1,000 potential buyers (only interested in a
  single unit each). Have different WTP ranging
  from 0 to 999
• Monopoly seller with constant per-unit cost of
  200,
• Sufficient capacity to supply everyone
• Question what quantity maximises monopolist
  profit?

10
Pooled pricing one price fits all

• Assume same price charged to everyone
• This is called pooled pricing
• Reasonable in markets with resale and arbitrage
• Customers cannot pay different prices
• Otherwise, ones with low price can re-sell (at
  profit) to others
• Later, we relax this assumption
• The monopolist faces a tradeoff
• Prices can be increased,
• But only at the expense of lower sales volume
  (and, visa versa)

11
What quantity do you choose?

• You have a monopoly in this market
• But, can you do whatever you want?
• For example, can you sell 800 units at a price of
  700?
• NO
• You can sell 800 units at 200 per unit
• Or you can price at 700, and sell 300 units
• You can choose price OR quantity, but not both!
• Quantity choices imply prices
• Price choices imply quantities
• Pick one or the other(well assume you choose
  quantity)

12
Changes in total revenue (TR)

• Consider TR as you increase quantity 1 unit at a
  time
• To sell 1 unit, price 999, TR 999
• To sell 2 units, price 998, TR 9982
  1,996
• Notice that, going from 1 unit to 2 units
• You have to drop price, which reduces what you
  get on unit 1
• You were getting 999
• Now you get 998
• But, you get to sell an additional unit at 998
• Dropping price, you lose 1 TR on unit 1 but gain
  998 on unit 2
• The net effect is an increase in TR of 1,996
  999 997
• As quantity increases 1 unit at a time
• You lose more and more TR from lower prices on
  previous units
• You gain less and less on the additional unit
  sold
• At some point, the losses exceed the gains!

13
Graphically TR from 4 to 5 units
The change in TR going from 4 to 5 units is 991
995 4
To sell 4 units, price 996
To sell 5 units, price 995
P 996
P 995
Lose 1 per unit on 4 units
TR area of rectangle 9964 3984
Gain995on5th unit
14
Output and Revenue over the range
15
Marginal revenue

• The marginal revenue (MR) of the nth unit is the
  change in total revenue induced by going from the
  (n 1)th unit
• In our example

Here, WTP is low (600) and the lost revenue on
previous units required to get the sale is large
(399) net effect 201
16
Graphically

• MR change in TR
• The marginal revenue of the 500th unit is 1
• The marginal revenue of the 502th unit is 3

17
Total cost (TC) versus marginal cost (MC)

• Costs can be analysed in exactly the same way
• The MC of the nth unit is the change in TC
  induced by moving production from (n 1) units
  to n units
• If you supply 100 units, MC additional cost of
  supplying 100 instead of 99
• In this example, each additional unit costs
  200? MC 200 for any level of production

18
Decision rule MR MC

• Monopolist should produce as long as doing so is
  profitable
• The monopolist wants to continue to expand sales
  up to the point where the last unit sold adds
  just enough TR to offset its effect on TC
• Obviously, if the overall effect on TR does not
  offset the overall effect on TC, dont produce
  it!
• Profit is maximised by producing 1 unit less than
  the first unit at which MR MC lt 0

19
Maximising Profit

• Marginal Profit
• (Revenue from another unit) - (cost of
  another unit)
• Marginal Revenue -
  Marginal Cost
• When should monopolist supply one more unit?
• Whenever the marginal profit is positive
• That is, until marginal profit just-above or
  equal to 0

Produce so long as MR ? MC!
20
Stopping rule for our example?

• Each additional unit yields less incremental
  revenue
• But each additional unit costs 200
• Each additional unit increases your total costs
  by 200
• Monopolist has constant marginal cost of 200
• If you earn more than 200 in revenue from
  increasing output by one more unit, do it!
• If you earn less than 200, dont!
• ? Stop when Marginal Revenue is 200

21
A Snapshot
MR MC goes negative here
Stop here
1
1
22
This can also be solved graphically
Profit maximising price
Point where MR MC
23
Restricting supply

• Motive for restricting supply, under bargaining
• reducing the bargaining power of buyers
• Motive for restricting supply, under posted
  pricing
• capturing more value from buyers with high WTP

24
Marginal Thinking

• Very powerful right way to approach any decision
  in which
• You can make choices in small increments
• Each increment brings less benefit
• Look at the last increment is it worth it?
• Should I study 8 or 9 hours, today?
• Should I eat another spoonful of ice cream?
• Marginal thinking, for the firm
• Should I produce one more unit?

25
Calculus shortcut

• Working through these calculations using the
  brute-force approach (i.e., unit-by-unit) is
  tedious, time-consuming and prone to error
• We can get very good approximations using
  calculus
• Cost learn appropriate calculus rules
• Benefit huge reduction in time spent working
  unit-by-unit cases
• For those who remember their calculus, cost 0
• To proceed, we need to make some simplifying
  assumptions

26
A necessary assumption

• To use calculus, must assume price-quantity
  relationship is smooth
• That is, must assume the relationship
• P 1000 Q
• holds for all quantities even non-integer
  amounts
• The equation above, called the inverse demand
  curve, describes price as a function of quantity

• Demand is actually lumpy
• At P 999.00, sell 1 units
• At P 998.50, sell 1 unit!

P 1000 Q
In large markets, it is simpler (and close
enough) to assume smooth demand At P 999.00,
sell 1 units At P 998.50, sell 1.5 units
27
Demand inverse demand curves

• The equation describing price as a function of
  quantity is called the inverse demand curve
• The sister equation, describing quantity as a
  function of price, is called the demand curve
• If we wish to treat quantity as the choice
  variable (we do), use inverse demand curve

• Key difference between lumpy and smooth demand
• Tiny change in quantity ? tiny change in price
• Indeed, changes can be infinitesimal
• When quantities are in the millions, increasing
  demand one unit is close to an infinitesimal
  change
• It may help to imagine the product is something
  divisible into arbitrary quantities, like petrol

P 1000 Q
28
Smooth TR curve

• Once we assume price is a smooth function of
  quantity, TR is also a smooth function of
  quantity
• TR Price x Quantity PQ
• So, substitute (1000 Q) in for price (from
  inverse demand equation) to get TR as a function
  of quantity only
• TR (1000 Q)Q 1000Q Q2

1000Q Q2
29
Marginal revenue of 500th unit
MR of 500th unit change in TR, 499 to 500 units
1
NOTE 1 slope of the line through these points
on the TR curve (slope rise over run)
But, with smooth TR, quantity increments can be
much smaller than 1 unit and, this is useful!
TotalRevenue
30
Maxima of smooth functions
The slope of a curve at a point is its
instantaneous rate of change at that point(e.g.,
the change in TR for a minuscule change in
quantity)
250,000
Notice anything special about this line?
249,999
FACT The maximum of a function occurs at the
point where its slope 0
FACT The instantaneous rate of change in TR at
a given quantity is the slope of the line tangent
to the TR curve at that quantity
TotalRevenue
31
Calculus the management summary

• The derivative of a curve at a particular point
  is the slope of the curve at that point
• To use calculus, you need to know the rule for
  finding the derivative
• Calculus knowledge for Man Ec
• If y is a function of x, the derivative of y
  with respect to x, denoted ?y/ ?x, is the slope
  of the function the rate at which y changes
  with x
• The only calculus rule you ever need (in this
  class) is that curves of the form
• where a, b and c are constants (may be positive,
  zero, or negative)
• Have derivatives of the form
• So, plug a number in for x to determine the slope
  of y(x) at that value of x

32
Why calculus is useful

• TR PQ 1000Q - Q 2
• To find the slope at any Q, write down the
  derivative using the only rule you will ever
  need
• This tells you the slope of the TR curve for any
  value of Q
• Total revenue hits its max when the slope 0

33
MR and MC with smooth functions

• MR at a specific Q is equal to the value of the
  derivative at the quantity
• From before,
• E.g., MR at Q 300 is 1000 2300 400
• The same idea applies to costs
• TC 200Q, so, using the only rule you will ever
  need
• MC at Q 300 is 200
• In this case, marginal costs are constant (the
  same at any level of production)

34
Firm objective maximise profit

• Now, lets apply the procedure to find maximum
  profit (what the monopolist really cares about!)
• Monopolist wishes to choose optimum Q
• Profit TR TC (1000Q Q2) 200Q 800Q
  Q2
• Apply the calculus rule to get
• Calculate where the slope equals 0

Notice same as the answerobtained using
brute-force
35
Graphically

• Same principle as before

Profit 1000Q Q2
Q
36
This can be stated as a marginal rule

• Marginal profit 800 2Q (1000 2Q) 200
• In other words, marginal profit MR MC
• MR 1000 2Q
• MC 200
• To maximise profit, set MR MC
• At the ideal output, Q
• 1000 - 2Q 200
• or
• Q 400
• To find ideal price, substitute Q into the
  inverse demand function
• P 1000 Q 600.

37
Exercise marginal cost

• Same demand curve as before, but now the cost of
  production is increasing
• Total Cost 200Q Q2.
• What is the cost of producing 30 units? 31 units?
  What is the marginal cost of the 31st unit?
• Calculate Marginal Cost, using derivatives. Is
  your answer for the marginal cost of the 31st
  unit approximately correct?
• How much does the monopolist choose to produce?
• Now suppose that you can sell as much as you want
  to on the US market, for 900 apiece, but demand
  in the Australian market is (1000 P). What do
  you do?

38
Why split profits into MR and MC?

• Marginal analysis is a powerful tool, beyond the
  case of one factory producing for one market
• If selling in two markets
• Equalise the MRs
• Why? Imagine you sell a fixed quantity (say 180)
• If MR higher in AU, do better by moving one unit
  from US to AU
• This gradually pushes MR down in Australia.
• Now choose total quantity set MR MC
• Double-check that you want to sell in both
  markets!

39
Similar plant production levels

• Assume 2 factories, 1 in Melbourne and 1 in
  Geelong
• Total Cost in Factory M 200QM
• Total Cost in Factory G 150QG QG2
• Same demand curve as before (can only sell in AU)
• How much do you produce in each factory?
• How about if the total cost in Factory G 300QG
  QG2?

40
Solution same idea as before
The marginal revenue and marginal cost equations
(for each plant) are
Set MC MR in both plants, solve for optimal
quantities (2 eqs, 2 unknowns)
When the marginal cost in factory G is 300 2QG
41
Elasticity

• A convenient measure of sensitivity for use in
  pricing

42
Your demand curve in ...the REAL world!

• Algebraic analysis is useful for building general
  intuition
• But not for setting prices in the real world
• Usually, you dont know the whole of your demand
  curve
• You do know at least one point on your demand
  curve demand at the current price
• You can experiment with slightly higher prices
  and slightly lower prices, to see how demand
  changes
• If you also know your marginal cost, thats
  enough to figure out if you should move your
  price up or down

43
Elasticity

• In determining Q P, it is important to know how
  sensitive demand is to price changes.
• If it is relatively insensitive, then by raising
  price the monopolist does not exclude many buyers
• If it is relatively sensitive, raising price can
  exclude many buyers
• The measure of how sensitive a demand function is
  to a change in price elasticity
• Prices are higher in markets with less sensitive
  demand (less elastic)
• In our example AU market more inelastic than US
• Price higher in Australia

44
Perfectly Elastic Demand
Price
Demand
Quantity
45
Perfectly Inelastic Demand
Price
Demand
Quantity
46
Calculating Elasticity

• Price elasticity of demand is the percentage
  change in quantity demanded divided by a given
  percentage change in price
• More often we use the point elasticity of demand
• elasticity for a minuscule percentage change
  in price
• (derivative of quantity with respect to price,
  times price divided by quantity)

47
Some Properties of Elasticity

• e is a negative number
• e.g., if 10 increase in price of oil decreases
  quantity by 20, e 2
• More elastic means Bigger in absolute value
• e.g., if eUS 2 and eAU 10, AU demand is
  more elastic
• Unit-Free Measure
• you can compare elasticities among different
  goods
• Is oil more price sensitive than butter, at their
  current prices?
• Elasticity vs. Slope
• These are not the same thing
• Slope is ?P/?Q

48
Some Terminology
49
Estimated Price Elasticities
Elasticities calculated at current market prices
50
Accounting for Differences

• Degree of Substitutability
• Temporary vs. Permanent Price Changes
• Long-run vs. Short-run elasticity

51
Price as a function of e

• This is useful for testing markups
• Get independent estimates of your marginal cost
  and e
• Check your price it should be

• From before,
• To maximise profit, set MR MC

• Alternatively
• Estimate e implied by current prices and marginal
  costs
• How does this track relative to your intuition
  regarding demand sensitivity?
• Compare against other industries
• Adjust price if necessary

52
The elasticity Sanity Check

• Suppose that you sell goods for 50 a unit. Your
  marginal costs are 20 a unit.
• An independent market research firm has estimated
  your elasticity of demand as -2.0.
• Should you consider increasing or decreasing your
  price by a little bit?

53
Linear (straight) demand

• Confusing!
• If the demand curve is actually straight, the
  elasticity is different at different points on
  the line.
• ?There is only one point at which the line has
  unit elasticity
• MR 0 at the unit elastic point
• If MC0, profits maximized when MR0
• Therefore, if MC0, produce at the unit elastic
  point
• CDs
• Software
• Amazon orders
• If MC gt 0, always price in the elastic portion of
  demand curve (e lt ?1)
• Marginal revenue is positive only on this part of
  the curve
• So, profit can only be maximised (MR MC) here
• Note this implies optimal prices (previous
  slide) are never negative

54

55
Innovative Pricing

• How to use price discrimination to increase value
  and profits

56
Linear Pricing

Triangles of Opportunity
P
Quantity
Q
57
Linear prices and lost opportunities

• From social point of view, value is lost
• ? Customers with WTP gt MC not served reduced
  surplus
• From firms point of view, more opportunity lost
• ? Many pay less than their WTP reduced
  appropriation
• Both triangles of opportunity attractive to
  firm
• ? Do both create more surplus beneficial to
  society

58
Railroads and Transport one price?

• Railroad tariffs specify charges based on the
  weight, volume, and distance of each shipment.
• For instance, discounts on the charge per mile
  per hundredweight are offered for full-car
  shipments and for long-distance shipments
• In other transport industries such as trucking,
  airlines, and parcel delivery the rates depend
  also on the speed of delivery or the time of the
  day, week, or season

59
Electricity one price?

• Electricity tariffs specify energy charges based
  on
• Total kilowatt hours used in the billing period,
  as well as
• Demand charges based on peak power load during
  year
• Lower rates apply to successive blocks of KWh
  (sometimes demand charges also divided into
  blocks)
• Energy rates for most industrial customers
  further differentiated by the time of use, as
  between peak and off-peak periods during the day

60
Price discrimination When customers have
different WTP

• By charging different prices to customers with
  different WTP, a monopolist can create more
  surplus
• To achieve this, the monopolist must find ways to
  charge different prices to different buyers
• segment the market.

61
How do you charge different prices?

• Cappuccino for the lavish 3.50
• Cappuccino for the thrifty 1.00

Will anyone say they are lavish? What if you
offer different coffees? One based on fair price
to growers. The other not.
62
Fair Trade Coffee

• Cappuccino for the concerned 3.50
• Cappuccino for the unconcerned 1.00

The difference is much less than the additional
premium paid to growers for fair trade
coffee. But, caused a stir
63
Revised Plan

• Cappuccino for the concerned 2.80
• Cappuccino for the unconcerned 2.50

So there are constraints on the ability to price
discriminate.
64
Origin Energy Green Power

• Pay for normal electricity
• Pay 25 more for electricity coming from green
  sources

65
Brunettis

• Hot chocolate 2.20
• Cappuccino 2.55
• Caffe Mocha 2.75
• White Chocolate Mocha 3.20
• 20 oz Cappuccino 3.40

66
Translation

• Hot chocolate no frills 2.20
• Cappuccino no frills 2.55
• Mix them together I feel special 2.75
• Use different powder I feel
• very special 3.20
• Make it huge I feel greedy 3.40

All of these have approximately the same cost to
the cafe
67
Types of price discrimination

• Personalised pricing
• Achieved by discriminating on individual
  observables charge different prices to
  different people.
• Group pricing Achieved by discriminating on
  group observables charge different prices to
  different groups whose WTPs are correlated with
  identifiable characteristics
• Versioning Achieved by discriminating on
  features charge more for products with special
  features of interest to high WTP customers

68
Personalised pricing

• Identify unique targets
• Car dealerships
• Discount cards and coupons
• Amazon tracking now defunct

69
Group pricing

• Why are there often discounts for seniors
  students?
• Students have lower WTP, on average,
• And, their demand is more elastic
• May want to charge lower price to them
• Membership in the group must be observable to the
  monopolist, to avoid arbitrage
• Arbitrage actions taken to exploit price
  differences
• Ex claiming youre a student

70
Geographic pricing

• Selling at different prices in different
  geographical markets is price discrimination!
• Pricing to different geographic markets
• Textbooks
• US edition textbook 70
• Indian edition textbook 5
• Arbitrage?
• US to AU air tickets vs. AU to US
• By neighborhood car insurance versus other goods
• Pharmaceuticals (effect of CAUS drug
  re-importing?)

71
Example Railroads

• Railroads set different prices for coal and grain
• Coal 2 or 3 times higher elasticity than grain?
  Should have a lower price
• How are markets segmented?

72
Versioning

• Find a feature that high WTP buyers care about
• Convenience,
• Release date, etc.
• High-WTP buyers must care more about this extra
  feature than low-WTP buyers
• Sell 2 versions of the product
• One with the feature
• One without
• Customers self-select they all look identical to
  the monopolist, but they decide which version to
  buy
• Versioning essentially no-cost product
  differentiation

73
Example Airline Tickets

• Why is there a discount for a Saturday night
  stay?
• Business travellers less likely to do so
• Price elasticity (discount passenger) 1.83
• Price elasticity (full economy passenger) 1.3
• What is the feature that high-WTP buyers pay
  for?
• ability to return on weekday
• Of course, ability to extract higher price
  limited by buyers next-best option

74
Quantity discounts

• Block Electricity Pricing
• Suppose there are large and small customers
• Charge a certain price up to x MWh
• Then, allow a discount
• Small buyer demand unchanged
• Larger buyers purchase more
• What is the feature offered? the right to
  buy small quantities

75
Making Self-Selection Work

• Adjust prices so that
• Low-WTP buyers want version without the feature
  price of the basic version is just below their
  WTP
• High-WTP buyers prefer version with the feature
  price at indifference point to next-best
  alternative
• Double-check that you earn more than with just
  one version!
• If both groups have same WTP for feature, both
  should have it!
• ? For price discrimination, feature should be one
  that high-WTP buyers value much more

76
Example Car with or without GPS

• High-WTP buyers
• WTP for car 40,000
• WTP for car with GPS 48,000
• ? WTP for the feature 8,000
• Low-WTP buyers
• WTP for car 30,000
• WTP for car with GPS 31,000
• Questions
• How do you price, so that low-WTP buy the basic
  car and high-WTP buy the car with GPS?
• If the cost of producing the car is 17,000 and
  the cost of producing installing GPS is 3,000,
  and 50 of buyers are low WTP, what will the
  monopolist do?

77
Price discrimination based on features

• Q How much extra is the high-WTP buyer going to
  pay for the version with feature?
• her WTP for the feature
• extra utility she gets from having the feature
• Example of GPS
• High-WTP buyer gets 8000 more utility from GPS
• The car with GPS will cost 8000 more than basic
• Basic will be priced at low-WTP
• Thats why you need a feature high-WTP people
  value a lot

78
Example Harry Potter delay

• Book sale can be immediate or one month later
• Buyer dislikes waiting
• Everyone else wants to talk about Harry Potter
  this month and
• Utility next month 50 of utility today
• Seller has no delay costs
• The seller can commit to a price schedule
• Price for this month (hardback)
• Price for next month (softback)
• ? feature offered no delay!
• (From a marketing point of view, its better if
  they view this months product as better, e.g.
  hardback)

79
Harry Potter price schedule

• Half the buyers have WTP of 60, and half have
  WTP of 40
• Production cost is 10 per book
• What price schedule does the seller choose w/o
  versioning? (in this case, its 40)
• With screening, choose prices so that
• High-WTP buyers purchase now
• Low-WTP buyers purchase later
• Second month price is 40
• What should todays price p be?
• Make high-WTP buyer indifferent
• 60 p gt 0.5 (60 - 40) 10
• So long as p is less than 50, will get
  self-selection

80
Profits from Screening

• The seller is using screening, that is,
  structuring prices to reveal information
• Get 40 from low-WTP buyers, and
• 50 from high-WTP buyers
• On average, price is 45
• Before screening, average price was 40
• Is this worth it?
• Gains could be small
• Yet it cost low value buyers a month of waiting
  
• ? might incur ill-will, maybe not worth it

81
Related examples inter-temporal effects

• Product life cycle discrimination
• Early buyers often have much more inelastic
  demand
• First-run movies
• Computer software
• Computer hardware
• CDs
• New sports equipment

82
Damaged goods

• Product crimping costly adjustments to create
  low-quality products in order to price
  discriminate
• Example Student versions of software, printer
  models
• What is the feature offered?
• better version of the product (i.e., not
  crimped)

83
Product differentiation

• Firms offer different products for reasons other
  than P-discrimination
• Horizontal differentiation
• Products of equal quality
• But different people prefer different features
• E.g., sweet cereals, crunchy cereals,
• Often, real reason to charge different prices for
  different goods
• Vertical differentiation
• Some products have superior quality
• Everyone agrees on whats the best good,
• Not everyone can afford extra cost to produce it
• E.g., supercomputers, Ferraris,
• Even if we earned 0 profits per sale, wed
  charge different prices for products
• Note crimping a product is clearly for pricing
  purposes only!(Even so, its not necessarily bad
  for customers)

84
Making self-selection work (continued)

• May need increase quality at high end (add more
  features)
• May need to cut quality at low end (reduce
  features)
• It may cost more to produce the low-quality
  version, if features have to be subtracted
• In design, make sure you can turn features off!
• You may want more than 2 versions of the product,
  if there is a range of different WTPs

85
Non-linear pricing Two-part tariffs

• Moulding individual purchases

86
Customers who demand multiple units

• Up to now, we have thought of a demand curve as
  being composed of many individuals, each with a
  different WTP (999,998,997,) and each wanting 1
  unit of the good only.
• But in many markets, most customers want more
  than 1 unit mobile phone minutes, for example
• A demand curve is still the right representation
  of the market!
• Example from our demand curve There could be 100
  identical consumers, who each demand 10 (P/100)
  units so if the price is 400, each customer
  wants 6 units, but if the price goes up to 500,
  each customer wants only 5 units.
• The quantity each customer buys will depend on
  the price.
• (In general, a demand function is composed of
  people with different willingness to pay for 1
  unit, different willingness to pay for a second
  unit, ex Designer clothing store.)

87
A revision to the on-going example

• Before 1000 consumers, each wants 1 unit, WTPs
  range from 0 to 999
• Now 100 identical consumers,
• Personal demand given by P 1000 100Q units
  so
• To sell each buyer 6 units (600 total) post P
  400
• At P 500, each customer wants only 5 units
• Individual demand curve

Maximum possible surplus per customer
1000

Individual Demand
MC
200
10
8
Quantity
88
Customers who demand multiple units

• Two-part prices allows a monopolist to extract
  more surplus from customers, in a
  variable-quantity market
• The following scheme works in this case
• Charge an up-front fee of 3200 per customer
• Post price of 200 per unit MC
• Each customer buys 8 units the
  surplus-maximising quantity
• This creates 3200 surplus, which monopolist
  extracts up-front

89
Applications of two-part pricing

• Water bill
• Telephone bill
• Internet unlimited-access accounts
• Mobile phone plans.

90
Two-part pricing

• Notice that there are two different reasons to
  offer two-part pricing
• Reason were looking at now
• the quantity a customer wants depends on the
  price
• they will demand more and get more surplus if the
  marginal price is lower
• and that extra surplus can be extracted through
  up-front fee
• Discrimination based on features
• customers buying more are more
  price-sensitive, more likely to walk away at a
  high price
• a two-part price gives a bulk discount to large
  users

91
Reality checks

• Does your firm really have scarcity power?
• If charge high price to some consumers, they may
  go to another firm
• Can your firm plug leaks?
• Consumers may re-sell goods from one group to
  another
• Basic products made even more basic!