Summary

1. By using pricing strategies, a firm with market power can extract more producer surplus from a market than it can from following the monopoly pricing rule of Chapter 9 (where the firm produces the quantity at which marginal revenue equals marginal cost, and then charges the price at which buyers would consume that quantity). It can only do so, however, if the situation satisfies certain criteria. A crucial factor is that in addition to market power, the firm has to be able to prevent resale among customers. If the firm can prevent resale, the amount of information it has on its customers determines what kind of pricing strategy it can follow. [Section 10.1]

2. When customers differ and the firm has sufficient information about its customers’ demands to charge every person a different price, perfect or first-degree price discrimination is possible. This strategy of direct price discrimination allows the firm to capture the entire surplus in the market for itself. It is very rare to have this kind of information, however. [Section 10.2]

3. If the firm has different types of customers and can directly identify at least two groups whose price elasticities of demand differ, it can charge different prices to the two groups and earn more producer surplus. The profit-maximizing direct price-discrimination strategy in this case is to follow the single-price monopoly pricing rule separately for each group. There are many ways to directly separate customers, including customer characteristics, geography, past purchase behavior, the timing of the purchase, and so on, a practice known as segmenting, or third-degree price discrimination. [Section 10.3]

4. If the company knows that there are different types of customers but cannot directly identify which group a customer belongs to before the purchase, it must rely on indirect (second-degree) price discrimination. This involves designing choices that induce customers to sort themselves into groups. Quantity discounts can be used if customers who demand a higher quantity also have a more elastic demand. Versioning a product can also work. The key additional requirement for indirect price discrimination is that the pricing structure has to be incentive-compatible, meaning that each consumer group wants to take the offer designed specifically for it. [Section 10.4]

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5. If a company sells multiple products and consumers’ demands for the products are negatively correlated, it can sell the products together as a bundle and increase producer surplus beyond what it could earn by selling the products separately. Sometimes, particularly if the marginal cost of producing one of the products exceeds the value that a customer places on that product, the company may be better off using mixed bundling, which gives customers the choice of buying individual products at high prices or a bundle of products at a discount. [Section 10.5]

6. Even when there are not different types of customers, a firm can use advanced pricing strategies like block pricing (a discount for buying extra quantity) or a two-part tariff (a fixed fee paid up-front in addition to a price per unit of the good) as a way to capture more producer surplus than it could earn with standard monopoly pricing. However, each of these strategies is much more complicated to implement when there are many consumers with different demand curves. [Section 10.6]