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Monopsony Power:Pricing With Market Power, Capturing Consumer Surplus

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Microeconomics ­ECO402
VU
Lesson 34
Monopsony Power
A few buyers can influence price (e.g. automobile industry).
Monopsony power gives them the ability to pay a price that is less than marginal value.
The degree of monopsony power depends on three similar factors.
1) Elasticity of market supply
·The less elastic the market supply, the greater the monopsony power.
2) Number of buyers
·The fewer the number of buyers, the less elastic the supply and the greater the monopsony
power.
3) Interaction Among Buyers
·The less the buyers compete, the greater the monopsony power.
Monopsony Power:
If the Elastic versus Inelastic Supply
ME
MV - P*
$/Q
$/Q
MV - P*
S = AE
ME
S = AE
P*
P*
MV
MV
Quantity
Q*
Q*
Quantity
Deadweight Loss from Monopsony Power in the
$/Q
ME
Deadweight Loss
S = AE
B
PC  A
C
P*
MV
Q*
QC
Quantity
158
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Microeconomics ­ECO402
VU
Determining the deadweight loss in monopsony
­ Change in seller's surplus = -A-C
­ Change in buyer's surplus = A - B
­ Change in welfare = -A - C + A - B = -C - B
­ Inefficiency occurs because less is purchased
The Social Cost of Monopsony Power
­  Bilateral Monopoly
·  Bilateral monopoly
is rare, however, markets with a small number of sellers with
monopoly power selling to a market with few buyers with monopsony power is more
common.
­  Question
·  In this case, what is likely to happen to price?
Limiting Market Power: The Antitrust Laws
Antitrust Laws:
­  Promote a competitive economy
­  Rules and regulations designed to promote a competitive economy by:
·  Prohibiting actions that restrain or are likely to restrain competition
·  Restricting the forms of market structures that are allowable
Pricing With Market Power
Pricing without market power (perfect competition) is determined by market supply and
demand.
The individual producer must be able to forecast the market and then concentrate on
managing production (cost) to maximize profits.
Pricing with market power (imperfect competition) requires the individual producer to know
much more about the characteristics of demand as well as manage production.
Capturing Consumer Surplus
Between 0 and Q*,
consumers
$/Q
Pma
A
will pay more than
P*--consumer surplus (A).
P1
PC is the price
that would exist in
B
P*
a perfectly
competitive
P2
If price is raised above
M
P*, the firm will lose
PC
sales and reduce profit.
D
Beyond Q*, price will
have to fall to create a
consumer surplus (B).
M
Quantity
Q*
159
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Microeconomics ­ECO402
VU
Capturing Consumer Surplus
·P*Q*: single P & Q @ MC=MR
·A: consumer surplus with P*
·B: P>MC & consumer would buy
at a lower price
·P1: less sales and profits
·P2 : increase sales & and reduce
revenue and profits
·PC: competitive price
Question How can the firm capture the consumer surplus in A and sell profitably in B?
Answer Price discrimination Two-part tariffs Bundling
Price discrimination is the charging of different prices to different consumers for similar
goods.
Price Discrimination
First Degree Price Discrimination
­ Charge a separate price to each customer: the maximum or reservation price they are
willing to pay.
Additional Profit From Perfect First-Degree Price Discrimination
Without price discrimination,
output is Q* and price is P*.
$/Q
Variable profit is the area
Pmax
Consumer surplus is the area
between the MC & MR.
above P* and between
0 and Q* output.
MC
P*
With perfect discrimination, each
consumer pays the maximum
price they are willing to pay.
PC
D = AR
Output expands to Q** and price
falls to PC where MC = MR = AR
= D.Profits increase by the area
MR
above MC
between old MR and D to output
Q**
Quantity
Q*
Q**
160
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Microeconomics ­ECO402
VU
With perfect discrimination
·  Each customer pays their
Consumer surplus when a
$/Q
Pmax
reservation price
single price P* is charged.
·Profits increase
Variable profit when a
single price P* is charged.
MC
P*
Additional profit from
perfect price discrimination
PC
D = AR
MR
Quantity
Q*
Q**
Question
­ Why would a producer have difficulty in achieving first-degree price discrimination?
Answer
1) Too many customers (impractical)
2) Could not estimate the reservation price for each customer
First Degree Price Discrimination
­ The model does demonstrate the potential profit (incentive) of practicing price
discrimination to some degree.
­ Examples of imperfect price discrimination where the seller has the ability to segregate
the market to some extent and charge different prices for the same product:
­ Lawyers, doctors, accountants
­ Car salesperson (15% profit margin)
­ Colleges and universities
First-Degree Price Discrimination in Practice
Six prices exist resulting
$/Q
in higher profits. With a single price
P1
P*4, there are few consumers and
those who pay P5 or P6 may have a
P2
surplus.
P3
MC
P*4
P5
P6
D
MR
Quantity
Q
161
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Microeconomics ­ECO402
VU
Second-Degree Price Discrimination
Second-degree price
discrimination is pricing
$/Q
according to quantity
consumed--or in blocks.
P1
Without discrimination: P = P0
and Q = Q0. With second-
P0
degree
discrimination there are three
prices P1, P2, and P3.
(e.g. electric utilities)
P2
AC
P3
MC
D
MR
Q0
Q1
Q2
Q3
Quantity
1st
2nd
3rd
Economies of scale permit:
·Increase consumer welfare
·Higher profits
162
Table of Contents:
  1. ECONOMICS:Themes of Microeconomics, Theories and Models
  2. Economics: Another Perspective, Factors of Production
  3. REAL VERSUS NOMINAL PRICES:SUPPLY AND DEMAND, The Demand Curve
  4. Changes in Market Equilibrium:Market for College Education
  5. Elasticities of supply and demand:The Demand for Gasoline
  6. Consumer Behavior:Consumer Preferences, Indifference curves
  7. CONSUMER PREFERENCES:Budget Constraints, Consumer Choice
  8. Note it is repeated:Consumer Preferences, Revealed Preferences
  9. MARGINAL UTILITY AND CONSUMER CHOICE:COST-OF-LIVING INDEXES
  10. Review of Consumer Equilibrium:INDIVIDUAL DEMAND, An Inferior Good
  11. Income & Substitution Effects:Determining the Market Demand Curve
  12. The Aggregate Demand For Wheat:NETWORK EXTERNALITIES
  13. Describing Risk:Unequal Probability Outcomes
  14. PREFERENCES TOWARD RISK:Risk Premium, Indifference Curve
  15. PREFERENCES TOWARD RISK:Reducing Risk, The Demand for Risky Assets
  16. The Technology of Production:Production Function for Food
  17. Production with Two Variable Inputs:Returns to Scale
  18. Measuring Cost: Which Costs Matter?:Cost in the Short Run
  19. A Firm’s Short-Run Costs ($):The Effect of Effluent Fees on Firms’ Input Choices
  20. Cost in the Long Run:Long-Run Cost with Economies & Diseconomies of Scale
  21. Production with Two Outputs--Economies of Scope:Cubic Cost Function
  22. Perfectly Competitive Markets:Choosing Output in Short Run
  23. A Competitive Firm Incurring Losses:Industry Supply in Short Run
  24. Elasticity of Market Supply:Producer Surplus for a Market
  25. Elasticity of Market Supply:Long-Run Competitive Equilibrium
  26. Elasticity of Market Supply:The Industry’s Long-Run Supply Curve
  27. Elasticity of Market Supply:Welfare loss if price is held below market-clearing level
  28. Price Supports:Supply Restrictions, Import Quotas and Tariffs
  29. The Sugar Quota:The Impact of a Tax or Subsidy, Subsidy
  30. Perfect Competition:Total, Marginal, and Average Revenue
  31. Perfect Competition:Effect of Excise Tax on Monopolist
  32. Monopoly:Elasticity of Demand and Price Markup, Sources of Monopoly Power
  33. The Social Costs of Monopoly Power:Price Regulation, Monopsony
  34. Monopsony Power:Pricing With Market Power, Capturing Consumer Surplus
  35. Monopsony Power:THE ECONOMICS OF COUPONS AND REBATES
  36. Airline Fares:Elasticities of Demand for Air Travel, The Two-Part Tariff
  37. Bundling:Consumption Decisions When Products are Bundled
  38. Bundling:Mixed Versus Pure Bundling, Effects of Advertising
  39. MONOPOLISTIC COMPETITION:Monopolistic Competition in the Market for Colas and Coffee
  40. OLIGOPOLY:Duopoly Example, Price Competition
  41. Competition Versus Collusion:The Prisoners’ Dilemma, Implications of the Prisoners
  42. COMPETITIVE FACTOR MARKETS:Marginal Revenue Product
  43. Competitive Factor Markets:The Demand for Jet Fuel
  44. Equilibrium in a Competitive Factor Market:Labor Market Equilibrium
  45. Factor Markets with Monopoly Power:Monopoly Power of Sellers of Labor