Oligopoly, Price discrimination

and Pricing Techniques

Cournots Model
Illustrates a market situation of duopoly.
There are two firms selling mineral water
They take decisions as if they are
operating independently in the market
One firm enters the market first and the
other follows

Assumes
Each firm maximizes profit at MR=MC
Cost of production is zero thus MC=0
Market demand is linear
Each firm decides on its price assuming
the other firms output is given.

As per cournots equilibrium is stable and

each firm will be maximizing profits by
selling equal amounts of output

Oligopoly
Kinked demand curve
Collusion or Cartel

Kinked Demand Curve

Introduced by Paul Sweezy in 1939
Oligopolist face a demand curve that is
highly elastic for price rise and less elastic
for price reductions, hence remains at one
level for a considerable time showing a
kink on the demand curve

Collusive Agreement
Since the number of firms are less they
are aware of the interdependency for a
clear increased profit, less uncertainty and
better opportunity to prevent entry
If the purpose of the cartel is to maximize
cartel profits, it will allocate sales to
firms in such a way that the MC of all
the firms is equal

Sales are often distributed in accord with a

firms level of sales in the past or the
production capacity and may also be
geographically.
Price is set by a leader

Centralized Cartel
Centralized Cartel sets the monopoly
price for the commodity, allocates the
monopoly output among the member
firms and determines how the monopoly
profits are to be shared.

Market Sharing Cartel

Here the member firms agree only on how
to share the market. Each firm operates in
only one area or region agreed upon,
without encroaching on the other
territories.

Price Leadership Cartel

The firm generally recognized as the price
leader starts the price change and the
other firms in the industry quickly follow.
The price leader is usually the dominant or
the largest firm in the Industry.

Price Discrimination

Price Discrimination
Price Discrimination: refers to the charging
of different prices for different quantities of
commodity or in different markets which
are not justified by cost differences.
Price Discrimination of first degree
Price Discrimination of Second degree
Price Discrimination of Third degree

Price Discrimination of first degree

If a monopolist could sell each unit of the
commodity separately and charge the
highest price each consumer is willing to
pay for the commodity rather than go
without it , the monopolist would be able to
extract the entire consumers surplus from
the consumer

Price Discrimination of Second degree

Refers to the charging of a uniform price
per unit for an specific quantity, a lower
price per unit for an additional batch of the
commodity and so on
By doing so the monopolist will be able to
extract a part but not all of the consumers
surplus

Price Discrimination of third degree

Charging different prices in different
markets is called as the third degree price
discrimination.

Pricing Techniques

Two Part Tariffs

A producer may sometimes require, the
consumer to pay an initial fee for the right
to buy its product as well as a usage fee
for each unit of the product that he or she
buys.

Tying
Tying is a pricing technique that is used
when the products are complementary to
each other

Bundling
A firm requires customers who buy one of
its products to buy another of its products
as well.

Max Price that the theater would pay for the two
movies, leased separately or as bundle
Movie

Theater
Alvin

Palace

Casablanca

$ 12,000

$ 9,000

The God Father

$ 8,000

$ 10,000

Bundle

$ 20,000

$ 19,000

Cost Plus Pricing

Cost plus pricing or full cost pricing is a
technique used by a large number of firms
The typical form involves two steps
The firm estimates the cost/unit of output
of the product
The firm adds a mark up (is meant to
include certain costs that cannot be
allocated to any specific product and to
provide a return on the firms investment)

Transfer Pricing
The price at which a product gets
transferred from one division to the other
is called as Transfer pricing.

Ramsay Pricing
Ramsay gave a model for taxation which
became very useful for pricing decisions of
a multi product firm.
He suggested that the government should
levy high tax on the goods which had low
price elasticity and low tax on goods which
had high price elasticity.