• Here, D(p) is the market demand the monopolist faces, C(q) is the cost
function
• We assume in the basic setup that the monopolist can only choose a con-
price
• Let’s take a closer look at where the demand D(p) comes from
1
• One convenient way is to say there are consumers with different “tastes”,
• So, the consumer with taste θ gets the following utility from consuming q
V (q, θ) = θq
• Suppose, for convenience, that each consumer can eat at most 1 unit.
• This means, given p, all consumers with taste θ > p will buy 1 unit of the
good.
• Suppose the taste parameter θ is distributed over the interval [θ, θ̄], where
– Here, F (θ) tells you what fraction of consumers has taste below θ
• F (θ) = 0; F (θ̄) = 1
• By setting any price p = θ ∈ [θ, θ̄], the monopolist sells 1 − F (θ) units.
(why?)
• So D(p) = 1 − F (p)
Assumptions
• F (θ) is continuous and differentiable for all θ ∈ [θ, θ̄]; (no atoms)
2
f (θ)
• The hazard rate, 1−F (θ) , is increasing in θ.
tributions.
• Now let’s consider a case where the monopolist does not have to choose a
• However, the consumer can decide not to buy anything, and get a payoff
of 0
• Denote now the monopolist’s cost of producing q units for one consumer
as c(q)
• c(q) is not the total cost function, but rather the cost of producing a
abstract away from things like increasing returns to scale that adds
more complexity
3
• With a non-linear pricing schedule T (q), the market demand D(p) isn’t
to sell to
– Still possible to set T (q) in such a way that excludes certain types
– But also possible to sell to all types and still make profits
F (θ))?
Revelation Principle
• The following result helps us find the optimal pricing schedule for the
monopolist:
– For any schedule T (·), which results in consumer with type θ max-
• Think of this as the monopolist committing to sell quantity q(θ) and charge
T (θ), if a consumer goes and tells the monopolist that his taste parameter
is θ.
4
• Here, q : [θ, θ̄] → [0, 1] and T : [θ, θ̄] → R
wθ̄
max {T (θ) − c(q(θ))} f (θ)dθ
q(·),T (·)
θ
Incentive-Compatibility Constraints
Proof
5
• Incentive compatibility means,
U (θ̂) − U (θ) ≥ θ̂ − θ q(θ)
• So,
θ − θ̂ q(θ̂) ≤ U (θ) − U (θ̂) ≤ θ − θ̂ q(θ)
U (θ) − U (θ̂)
q(θ̂) ≤ ≤ q(θ) ; assuming θ > θ̂
θ − θ̂
θ − θ̂ q(θ̂) ≤ U (θ) − U (θ̂) ≤ θ − θ̂ q(θ)
U (θ) − U (θ̂)
U 0 (θ) = lim = q(θ)
θ̂→θ θ − θ̂
6
envelope condition:
wθ
U (θ) = U (θ) + q(t)dt
θ
Payments
• Notice that
• This means that T (·) is uniquely pinned down, up to the constant U (θ),
lem:
wθ̄ wθ
max θq(θ) − c(q(θ)) − q(t)dt f (θ)dθ
q(·)
θ θ
constraint, find the optimal q(·), and then check that monotonicity is
7
satisfied.
control.
wθ̄ 1 − F (θ)
θq(θ) − c(q(θ)) − q(θ) f (θ)dθ
f (θ)
θ
wθ̄ 1 − F (θ)
= θ− q(θ) − c(q(θ)) f (θ)dθ
f (θ)
θ
• Notice now that we can just pointwise maximize the term inside the second
bracket, choosing q.
1 − F (θ)
max θ − q − c(q)
q f (θ)
1−F (θ)
• FOC: θ − f (θ) − c0 (q) = 0
f (θ)
• Remember the monotone hazard rate condition: 1−F (θ) is increasing in θ
1−F (θ)
• This means θ − f (θ) is strictly increasing in θ
8
1 − F (θ)
c0 (q(θ)) = θ −
f (θ)
• The RHS is increasing for higher types, so the solution involves setting
is satisfied.
• Food for thought: think what the optimal q(θ) would be with constant
marginal cost.
types?
wθ̄
max {(θq(θ) − T (θ)) + (T (θ) − c(q(θ)))} f (θ)dθ
q(·)
θ
wθ̄
max {θq(θ) − c(q(θ))} f (θ)dθ
q(·)
θ
1−F (θ)
• Monopolist chooses to set c0 (q(θ)) = θ − f (θ)
• Chooses less than the first-best quantity for all types θ < θ̄