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Industrial Organisation Off and On the InternetSome Lessons From the Past
Greg Taylor
Oxford Internet InstituteUniversity of Oxford
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Economics
I The study of constrained choice.
I Build mathematical models of decision makers’ behaviours.I Typically gives us very sharp conclusions.I Suggests effects of policy changes—comparative statics.I But hard: the world is very complex, so we need assumptions.I Thus another advantage of the mathematical approach:
encourages transparency of assumptions.
I Let’s take a look at a textbook example of how some simpleassumptions can be turned into a model.
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Economics
I The study of constrained choice.I Build mathematical models of decision makers’ behaviours.
I Typically gives us very sharp conclusions.I Suggests effects of policy changes—comparative statics.I But hard: the world is very complex, so we need assumptions.I Thus another advantage of the mathematical approach:
encourages transparency of assumptions.
I Let’s take a look at a textbook example of how some simpleassumptions can be turned into a model.
![Page 4: Industrial Organisation Off and On the Internet](https://reader033.vdocument.in/reader033/viewer/2022060115/5579f94cd8b42abc2e8b4e40/html5/thumbnails/4.jpg)
Economics
I The study of constrained choice.I Build mathematical models of decision makers’ behaviours.
I Typically gives us very sharp conclusions.
I Suggests effects of policy changes—comparative statics.I But hard: the world is very complex, so we need assumptions.I Thus another advantage of the mathematical approach:
encourages transparency of assumptions.
I Let’s take a look at a textbook example of how some simpleassumptions can be turned into a model.
![Page 5: Industrial Organisation Off and On the Internet](https://reader033.vdocument.in/reader033/viewer/2022060115/5579f94cd8b42abc2e8b4e40/html5/thumbnails/5.jpg)
Economics
I The study of constrained choice.I Build mathematical models of decision makers’ behaviours.
I Typically gives us very sharp conclusions.I Suggests effects of policy changes—comparative statics.
I But hard: the world is very complex, so we need assumptions.I Thus another advantage of the mathematical approach:
encourages transparency of assumptions.
I Let’s take a look at a textbook example of how some simpleassumptions can be turned into a model.
![Page 6: Industrial Organisation Off and On the Internet](https://reader033.vdocument.in/reader033/viewer/2022060115/5579f94cd8b42abc2e8b4e40/html5/thumbnails/6.jpg)
Economics
I The study of constrained choice.I Build mathematical models of decision makers’ behaviours.
I Typically gives us very sharp conclusions.I Suggests effects of policy changes—comparative statics.I But hard: the world is very complex, so we need assumptions.
I Thus another advantage of the mathematical approach:encourages transparency of assumptions.
I Let’s take a look at a textbook example of how some simpleassumptions can be turned into a model.
![Page 7: Industrial Organisation Off and On the Internet](https://reader033.vdocument.in/reader033/viewer/2022060115/5579f94cd8b42abc2e8b4e40/html5/thumbnails/7.jpg)
Economics
I The study of constrained choice.I Build mathematical models of decision makers’ behaviours.
I Typically gives us very sharp conclusions.I Suggests effects of policy changes—comparative statics.I But hard: the world is very complex, so we need assumptions.I Thus another advantage of the mathematical approach:
encourages transparency of assumptions.
I Let’s take a look at a textbook example of how some simpleassumptions can be turned into a model.
![Page 8: Industrial Organisation Off and On the Internet](https://reader033.vdocument.in/reader033/viewer/2022060115/5579f94cd8b42abc2e8b4e40/html5/thumbnails/8.jpg)
Economics
I The study of constrained choice.I Build mathematical models of decision makers’ behaviours.
I Typically gives us very sharp conclusions.I Suggests effects of policy changes—comparative statics.I But hard: the world is very complex, so we need assumptions.I Thus another advantage of the mathematical approach:
encourages transparency of assumptions.
I Let’s take a look at a textbook example of how some simpleassumptions can be turned into a model.
![Page 9: Industrial Organisation Off and On the Internet](https://reader033.vdocument.in/reader033/viewer/2022060115/5579f94cd8b42abc2e8b4e40/html5/thumbnails/9.jpg)
Outline
Price discrimination: from assumptions to policy statements
Assumptions and applicability
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Price discrimination
I Price discrimination is the practice of pricing such thatdifferent groups of consumers yield different price-costmargins for the firm.
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A price discrimination example
I Imagine a monopolist firm that sells some products of varyingquality.
I Assume that quality can be indexed by a number, q.I Let q be continuous.I Suppose that it costs C(q) to provide a product with quality q.
Let C ′(q) > 0 (increasing costs), C ′′(q) > 0 (convex costs),and C(0) = 0.
I There are two types of customer: low (L), and high (H).
I A type i ∈ {L,H} consumer enjoys surplus
Ui = θiq − p.
where p is the price to be paid to the firm, and θi is theconsumer’s willingness to pay for a one unit increase in quality.
I Let θL < θH .
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A price discrimination example
I Imagine a monopolist firm that sells some products of varyingquality.
I Assume that quality can be indexed by a number, q.I Let q be continuous.I Suppose that it costs C(q) to provide a product with quality q.
Let C ′(q) > 0 (increasing costs), C ′′(q) > 0 (convex costs),and C(0) = 0.
I There are two types of customer: low (L), and high (H).
I A type i ∈ {L,H} consumer enjoys surplus
Ui = θiq − p.
where p is the price to be paid to the firm, and θi is theconsumer’s willingness to pay for a one unit increase in quality.
I Let θL < θH .
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A price discrimination example
I Imagine a monopolist firm that sells some products of varyingquality.
I Assume that quality can be indexed by a number, q.I Let q be continuous.I Suppose that it costs C(q) to provide a product with quality q.
Let C ′(q) > 0 (increasing costs), C ′′(q) > 0 (convex costs),and C(0) = 0.
I There are two types of customer: low (L), and high (H).
I A type i ∈ {L,H} consumer enjoys surplus
Ui = θiq − p.
where p is the price to be paid to the firm, and θi is theconsumer’s willingness to pay for a one unit increase in quality.
I Let θL < θH .
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A price discrimination example
I Imagine a monopolist firm that sells some products of varyingquality.
I Assume that quality can be indexed by a number, q.I Let q be continuous.I Suppose that it costs C(q) to provide a product with quality q.
Let C ′(q) > 0 (increasing costs), C ′′(q) > 0 (convex costs),and C(0) = 0.
I There are two types of customer: low (L), and high (H).
I A type i ∈ {L,H} consumer enjoys surplus
Ui = θiq − p.
where p is the price to be paid to the firm, and θi is theconsumer’s willingness to pay for a one unit increase in quality.
I Let θL < θH .
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A price discrimination example
I Imagine a monopolist firm that sells some products of varyingquality.
I Assume that quality can be indexed by a number, q.I Let q be continuous.I Suppose that it costs C(q) to provide a product with quality q.
Let C ′(q) > 0 (increasing costs), C ′′(q) > 0 (convex costs),and C(0) = 0.
I There are two types of customer: low (L), and high (H).
I A type i ∈ {L,H} consumer enjoys surplus
Ui = θiq − p.
where p is the price to be paid to the firm, and θi is theconsumer’s willingness to pay for a one unit increase in quality.
I Let θL < θH .
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First order discrimination
I In a perfect world, the firm would know the type of consumerit is facing.
I It could then design a product/price combination for eachtype.
I i.e. Sell a ‘budget’ product with q = qL at price pL to L-typeconsumers, and a ‘luxury’ product with q = qH at price pH .
I The firm’s objective would then be to
maxqi,pi
pi − C(qi)
subject to the constraint
θiqi − pi ≥ 0.
I This kind of behaviour is called first degree pricediscrimination.
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First order discrimination
I In a perfect world, the firm would know the type of consumerit is facing.
I It could then design a product/price combination for eachtype.
I i.e. Sell a ‘budget’ product with q = qL at price pL to L-typeconsumers, and a ‘luxury’ product with q = qH at price pH .
I The firm’s objective would then be to
maxqi,pi
pi − C(qi)
subject to the constraint
θiqi − pi ≥ 0.
I This kind of behaviour is called first degree pricediscrimination.
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First order discrimination
I In a perfect world, the firm would know the type of consumerit is facing.
I It could then design a product/price combination for eachtype.
I i.e. Sell a ‘budget’ product with q = qL at price pL to L-typeconsumers, and a ‘luxury’ product with q = qH at price pH .
I The firm’s objective would then be to
maxqi,pi
pi − C(qi)
subject to the constraint
θiqi − pi ≥ 0.
I This kind of behaviour is called first degree pricediscrimination.
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First order discrimination
I In a perfect world, the firm would know the type of consumerit is facing.
I It could then design a product/price combination for eachtype.
I i.e. Sell a ‘budget’ product with q = qL at price pL to L-typeconsumers, and a ‘luxury’ product with q = qH at price pH .
I The firm’s objective would then be to
maxqi,pi
pi − C(qi)
subject to the constraint
θiqi − pi ≥ 0.
I This kind of behaviour is called first degree pricediscrimination.
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First order discrimination
I In a perfect world, the firm would know the type of consumerit is facing.
I It could then design a product/price combination for eachtype.
I i.e. Sell a ‘budget’ product with q = qL at price pL to L-typeconsumers, and a ‘luxury’ product with q = qH at price pH .
I The firm’s objective would then be to
maxqi,pi
pi − C(qi)
subject to the constraint
θiqi − pi ≥ 0.
I This kind of behaviour is called first degree pricediscrimination.
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First order discrimination
maxqi,pi
pi − C(qi) s.t. θiqi − pi ≥ 0.
I In fact, since the firm knows θi, it can just set pi = θiqi.
I Substituting this into the maximisation problem gives
maxqi
θiqi − C(qi).
I Increasing qi by one unit increases revenue by θi, and cost byC ′(qi).
I It is therefore profitable to increase quality if and only ifθi > C ′(qi).
I So quality q∗i is produced where θi = C ′(qi), i.e. wheremarginal cost of qi is equal to marginal willingness to pay forit.
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First order discrimination
maxqi,pi
pi − C(qi) s.t. θiqi − pi ≥ 0.
I In fact, since the firm knows θi, it can just set pi = θiqi.
I Substituting this into the maximisation problem gives
maxqi
θiqi − C(qi).
I Increasing qi by one unit increases revenue by θi, and cost byC ′(qi).
I It is therefore profitable to increase quality if and only ifθi > C ′(qi).
I So quality q∗i is produced where θi = C ′(qi), i.e. wheremarginal cost of qi is equal to marginal willingness to pay forit.
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First order discrimination
maxqi,pi
pi − C(qi) s.t. θiqi − pi ≥ 0.
I In fact, since the firm knows θi, it can just set pi = θiqi.
I Substituting this into the maximisation problem gives
maxqi
θiqi − C(qi).
I Increasing qi by one unit increases revenue by θi, and cost byC ′(qi).
I It is therefore profitable to increase quality if and only ifθi > C ′(qi).
I So quality q∗i is produced where θi = C ′(qi), i.e. wheremarginal cost of qi is equal to marginal willingness to pay forit.
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First order discrimination
maxqi,pi
pi − C(qi) s.t. θiqi − pi ≥ 0.
I In fact, since the firm knows θi, it can just set pi = θiqi.
I Substituting this into the maximisation problem gives
maxqi
θiqi − C(qi).
I Increasing qi by one unit increases revenue by θi, and cost byC ′(qi).
I It is therefore profitable to increase quality if and only ifθi > C ′(qi).
I So quality q∗i is produced where θi = C ′(qi), i.e. wheremarginal cost of qi is equal to marginal willingness to pay forit.
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First order discrimination
maxqi,pi
pi − C(qi) s.t. θiqi − pi ≥ 0.
I In fact, since the firm knows θi, it can just set pi = θiqi.
I Substituting this into the maximisation problem gives
maxqi
θiqi − C(qi).
I Increasing qi by one unit increases revenue by θi, and cost byC ′(qi).
I It is therefore profitable to increase quality if and only ifθi > C ′(qi).
I So quality q∗i is produced where θi = C ′(qi), i.e. wheremarginal cost of qi is equal to marginal willingness to pay forit.
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First order discrimination
maxqi,pi
pi − C(qi) s.t. θiqi − pi ≥ 0.
I In fact, since the firm knows θi, it can just set pi = θiqi.
I Substituting this into the maximisation problem gives
maxqi
θiqi − C(qi).
I Increasing qi by one unit increases revenue by θi, and cost byC ′(qi).
I It is therefore profitable to increase quality if and only ifθi > C ′(qi).
I So quality q∗i is produced where θi = C ′(qi), i.e. wheremarginal cost of qi is equal to marginal willingness to pay forit.
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What can we say about these qs?
I Firstly, by giving firms so much information about consumers,we have left the latter with no surplus.
I However, that θi = C ′(qi) implies the chosen qualities areefficient!
I Social welfare given by consumer + firm welfare:
(θiqi − p) + (p− C(qi)) = θiqi − C(qi).
I This is exactly what the firm is maximising!
I That θi = C ′(qi) also implies that qL < qH , and hencepL < pH .
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What can we say about these qs?
I Firstly, by giving firms so much information about consumers,we have left the latter with no surplus.
I However, that θi = C ′(qi) implies the chosen qualities areefficient!
I Social welfare given by consumer + firm welfare:
(θiqi − p) + (p− C(qi)) = θiqi − C(qi).
I This is exactly what the firm is maximising!
I That θi = C ′(qi) also implies that qL < qH , and hencepL < pH .
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What can we say about these qs?
I Firstly, by giving firms so much information about consumers,we have left the latter with no surplus.
I However, that θi = C ′(qi) implies the chosen qualities areefficient!
I Social welfare given by consumer + firm welfare:
(θiqi − p) + (p− C(qi))
= θiqi − C(qi).
I This is exactly what the firm is maximising!
I That θi = C ′(qi) also implies that qL < qH , and hencepL < pH .
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What can we say about these qs?
I Firstly, by giving firms so much information about consumers,we have left the latter with no surplus.
I However, that θi = C ′(qi) implies the chosen qualities areefficient!
I Social welfare given by consumer + firm welfare:
(θiqi − p) + (p− C(qi)) = θiqi − C(qi).
I This is exactly what the firm is maximising!
I That θi = C ′(qi) also implies that qL < qH , and hencepL < pH .
![Page 31: Industrial Organisation Off and On the Internet](https://reader033.vdocument.in/reader033/viewer/2022060115/5579f94cd8b42abc2e8b4e40/html5/thumbnails/31.jpg)
What can we say about these qs?
I Firstly, by giving firms so much information about consumers,we have left the latter with no surplus.
I However, that θi = C ′(qi) implies the chosen qualities areefficient!
I Social welfare given by consumer + firm welfare:
(θiqi − p) + (p− C(qi)) = θiqi − C(qi).
I This is exactly what the firm is maximising!
I That θi = C ′(qi) also implies that qL < qH , and hencepL < pH .
![Page 32: Industrial Organisation Off and On the Internet](https://reader033.vdocument.in/reader033/viewer/2022060115/5579f94cd8b42abc2e8b4e40/html5/thumbnails/32.jpg)
What can we say about these qs?
I Firstly, by giving firms so much information about consumers,we have left the latter with no surplus.
I However, that θi = C ′(qi) implies the chosen qualities areefficient!
I Social welfare given by consumer + firm welfare:
(θiqi − p) + (p− C(qi)) = θiqi − C(qi).
I This is exactly what the firm is maximising!
I That θi = C ′(qi) also implies that qL < qH , and hencepL < pH .
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Segmentation breakdown
I Now, firms typically cannot observe θi and so must depend onthe consumer to buy the product designed for them.
I Therein lies a problem: if high consumers buy the high qualityproduct, they get
θHqH − pH = θHqH − θHqH = 0,
whereas if they buy the low quality product, they get
θHqL − pL > θLqL − pL = 0.
I Thus, all consumers will buy the budget product—this iscalled adverse selection.
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Segmentation breakdown
I Now, firms typically cannot observe θi and so must depend onthe consumer to buy the product designed for them.
I Therein lies a problem: if high consumers buy the high qualityproduct, they get
θHqH − pH = θHqH − θHqH = 0,
whereas if they buy the low quality product, they get
θHqL − pL > θLqL − pL = 0.
I Thus, all consumers will buy the budget product—this iscalled adverse selection.
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Segmentation breakdown
I Now, firms typically cannot observe θi and so must depend onthe consumer to buy the product designed for them.
I Therein lies a problem: if high consumers buy the high qualityproduct, they get
θHqH − pH = θHqH − θHqH = 0,
whereas if they buy the low quality product, they get
θHqL − pL
> θLqL − pL = 0.
I Thus, all consumers will buy the budget product—this iscalled adverse selection.
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Segmentation breakdown
I Now, firms typically cannot observe θi and so must depend onthe consumer to buy the product designed for them.
I Therein lies a problem: if high consumers buy the high qualityproduct, they get
θHqH − pH = θHqH − θHqH = 0,
whereas if they buy the low quality product, they get
θHqL − pL > θLqL − pL
= 0.
I Thus, all consumers will buy the budget product—this iscalled adverse selection.
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Segmentation breakdown
I Now, firms typically cannot observe θi and so must depend onthe consumer to buy the product designed for them.
I Therein lies a problem: if high consumers buy the high qualityproduct, they get
θHqH − pH = θHqH − θHqH = 0,
whereas if they buy the low quality product, they get
θHqL − pL > θLqL − pL = 0.
I Thus, all consumers will buy the budget product—this iscalled adverse selection.
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Segmentation breakdown
I Now, firms typically cannot observe θi and so must depend onthe consumer to buy the product designed for them.
I Therein lies a problem: if high consumers buy the high qualityproduct, they get
θHqH − pH = θHqH − θHqH = 0,
whereas if they buy the low quality product, they get
θHqL − pL > θLqL − pL = 0.
I Thus, all consumers will buy the budget product—this iscalled adverse selection.
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Solution: mechanism designI Question: What can the firm do about this?
I Answer: Change it’s maximisation problem.I Suppose a consumer is of type L with probability α and of
type H with probability (1− α). The new problem is then:
maxqL,pL,qH ,pH
α(pL − C(qL)) + (1− α)(pH − C(qH))
subject to the constraint
θHqH − pH ≥ θHqL − pL (ICH)
θLqL − pL ≥ θHqH − pH (ICL)
θHqH − pH ≥ 0 (IRH)
θLqL − pL ≥ 0 (IRL)
I Solving such a problem is known as second degree pricediscrimination.
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Solution: mechanism designI Question: What can the firm do about this?I Answer: Change it’s maximisation problem.
I Suppose a consumer is of type L with probability α and oftype H with probability (1− α). The new problem is then:
maxqL,pL,qH ,pH
α(pL − C(qL)) + (1− α)(pH − C(qH))
subject to the constraint
θHqH − pH ≥ θHqL − pL (ICH)
θLqL − pL ≥ θHqH − pH (ICL)
θHqH − pH ≥ 0 (IRH)
θLqL − pL ≥ 0 (IRL)
I Solving such a problem is known as second degree pricediscrimination.
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Solution: mechanism designI Question: What can the firm do about this?I Answer: Change it’s maximisation problem.I Suppose a consumer is of type L with probability α and of
type H with probability (1− α).
The new problem is then:
maxqL,pL,qH ,pH
α(pL − C(qL)) + (1− α)(pH − C(qH))
subject to the constraint
θHqH − pH ≥ θHqL − pL (ICH)
θLqL − pL ≥ θHqH − pH (ICL)
θHqH − pH ≥ 0 (IRH)
θLqL − pL ≥ 0 (IRL)
I Solving such a problem is known as second degree pricediscrimination.
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Solution: mechanism designI Question: What can the firm do about this?I Answer: Change it’s maximisation problem.I Suppose a consumer is of type L with probability α and of
type H with probability (1− α). The new problem is then:
maxqL,pL,qH ,pH
α(pL − C(qL)) + (1− α)(pH − C(qH))
subject to the constraint
θHqH − pH ≥ θHqL − pL (ICH)
θLqL − pL ≥ θHqH − pH (ICL)
θHqH − pH ≥ 0 (IRH)
θLqL − pL ≥ 0 (IRL)
I Solving such a problem is known as second degree pricediscrimination.
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Solution: mechanism designI Question: What can the firm do about this?I Answer: Change it’s maximisation problem.I Suppose a consumer is of type L with probability α and of
type H with probability (1− α). The new problem is then:
maxqL,pL,qH ,pH
α(pL − C(qL)) + (1− α)(pH − C(qH))
subject to the constraint
θHqH − pH ≥ θHqL − pL (ICH)
θLqL − pL ≥ θHqH − pH (ICL)
θHqH − pH ≥ 0 (IRH)
θLqL − pL ≥ 0 (IRL)
I Solving such a problem is known as second degree pricediscrimination.
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Solution: mechanism designI Question: What can the firm do about this?I Answer: Change it’s maximisation problem.I Suppose a consumer is of type L with probability α and of
type H with probability (1− α). The new problem is then:
maxqL,pL,qH ,pH
α(pL − C(qL)) + (1− α)(pH − C(qH))
subject to the constraint
θHqH − pH ≥ θHqL − pL (ICH)
θLqL − pL ≥ θHqH − pH (ICL)
θHqH − pH ≥ 0 (IRH)
θLqL − pL ≥ 0 (IRL)
I Solving such a problem is known as second degree pricediscrimination.
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IRL is ‘binding’
I Let’s begin by establishing that IRL holds with equality i.e.that θLqL − pL = 0.
I This means that home users are left with no surplus.
I ICH says
θHqH − pH ≥ θHqL − pL ≥ θLqL − pL
I Thus, if θLqL − pL > 0, then it must also be true thatθHqH − pH > 0 so that neither IRL nor IRH bind.
I But then the firm could increase both pL and pH withoutviolating any condition.
I This implies that IRL must bind at the optimum.
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IRL is ‘binding’
I Let’s begin by establishing that IRL holds with equality i.e.that θLqL − pL = 0.
I This means that home users are left with no surplus.
I ICH says
θHqH − pH ≥ θHqL − pL
≥ θLqL − pL
I Thus, if θLqL − pL > 0, then it must also be true thatθHqH − pH > 0 so that neither IRL nor IRH bind.
I But then the firm could increase both pL and pH withoutviolating any condition.
I This implies that IRL must bind at the optimum.
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IRL is ‘binding’
I Let’s begin by establishing that IRL holds with equality i.e.that θLqL − pL = 0.
I This means that home users are left with no surplus.
I ICH says
θHqH − pH ≥ θHqL − pL ≥ θLqL − pL
I Thus, if θLqL − pL > 0, then it must also be true thatθHqH − pH > 0 so that neither IRL nor IRH bind.
I But then the firm could increase both pL and pH withoutviolating any condition.
I This implies that IRL must bind at the optimum.
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IRL is ‘binding’
I Let’s begin by establishing that IRL holds with equality i.e.that θLqL − pL = 0.
I This means that home users are left with no surplus.
I ICH says
θHqH − pH ≥ θHqL − pL ≥ θLqL − pL
I Thus, if θLqL − pL > 0, then it must also be true thatθHqH − pH > 0 so that neither IRL nor IRH bind.
I But then the firm could increase both pL and pH withoutviolating any condition.
I This implies that IRL must bind at the optimum.
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IRL is ‘binding’
I Let’s begin by establishing that IRL holds with equality i.e.that θLqL − pL = 0.
I This means that home users are left with no surplus.
I ICH says
θHqH − pH ≥ θHqL − pL ≥ θLqL − pL
I Thus, if θLqL − pL > 0, then it must also be true thatθHqH − pH > 0 so that neither IRL nor IRH bind.
I But then the firm could increase both pL and pH withoutviolating any condition.
I This implies that IRL must bind at the optimum.
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IRL is ‘binding’
I Let’s begin by establishing that IRL holds with equality i.e.that θLqL − pL = 0.
I This means that home users are left with no surplus.
I ICH says
θHqH − pH ≥ θHqL − pL ≥ θLqL − pL
I Thus, if θLqL − pL > 0, then it must also be true thatθHqH − pH > 0 so that neither IRL nor IRH bind.
I But then the firm could increase both pL and pH withoutviolating any condition.
I This implies that IRL must bind at the optimum.
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ICH is ‘binding’
I We next show that ICH holds with equality i.e. thatθHqH − pH = θHqL − pL.
I This means if the deal for the luxury product got any worsethen H type consumers would switch to buying the budgetproduct.
I Suppose that this weren’t true:
θHqH − pH > θHqL − pL ≥ θLqL − pL = 0
I Thus, if ICH does not bind then neither does IRH.
I But then the firm could increase pH without violating anycondition.
I This implies that ICH must bind at the optimum.
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ICH is ‘binding’
I We next show that ICH holds with equality i.e. thatθHqH − pH = θHqL − pL.
I This means if the deal for the luxury product got any worsethen H type consumers would switch to buying the budgetproduct.
I Suppose that this weren’t true:
θHqH − pH > θHqL − pL
≥ θLqL − pL = 0
I Thus, if ICH does not bind then neither does IRH.
I But then the firm could increase pH without violating anycondition.
I This implies that ICH must bind at the optimum.
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ICH is ‘binding’
I We next show that ICH holds with equality i.e. thatθHqH − pH = θHqL − pL.
I This means if the deal for the luxury product got any worsethen H type consumers would switch to buying the budgetproduct.
I Suppose that this weren’t true:
θHqH − pH > θHqL − pL ≥ θLqL − pL
= 0
I Thus, if ICH does not bind then neither does IRH.
I But then the firm could increase pH without violating anycondition.
I This implies that ICH must bind at the optimum.
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ICH is ‘binding’
I We next show that ICH holds with equality i.e. thatθHqH − pH = θHqL − pL.
I This means if the deal for the luxury product got any worsethen H type consumers would switch to buying the budgetproduct.
I Suppose that this weren’t true:
θHqH − pH > θHqL − pL ≥ θLqL − pL = 0
I Thus, if ICH does not bind then neither does IRH.
I But then the firm could increase pH without violating anycondition.
I This implies that ICH must bind at the optimum.
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ICH is ‘binding’
I We next show that ICH holds with equality i.e. thatθHqH − pH = θHqL − pL.
I This means if the deal for the luxury product got any worsethen H type consumers would switch to buying the budgetproduct.
I Suppose that this weren’t true:
θHqH − pH > θHqL − pL ≥ θLqL − pL = 0
I Thus, if ICH does not bind then neither does IRH.
I But then the firm could increase pH without violating anycondition.
I This implies that ICH must bind at the optimum.
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ICH is ‘binding’
I We next show that ICH holds with equality i.e. thatθHqH − pH = θHqL − pL.
I This means if the deal for the luxury product got any worsethen H type consumers would switch to buying the budgetproduct.
I Suppose that this weren’t true:
θHqH − pH > θHqL − pL ≥ θLqL − pL = 0
I Thus, if ICH does not bind then neither does IRH.
I But then the firm could increase pH without violating anycondition.
I This implies that ICH must bind at the optimum.
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ICH is ‘binding’
I We next show that ICH holds with equality i.e. thatθHqH − pH = θHqL − pL.
I This means if the deal for the luxury product got any worsethen H type consumers would switch to buying the budgetproduct.
I Suppose that this weren’t true:
θHqH − pH > θHqL − pL ≥ θLqL − pL = 0
I Thus, if ICH does not bind then neither does IRH.
I But then the firm could increase pH without violating anycondition.
I This implies that ICH must bind at the optimum.
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Can neglect IRH and ICL
I That ICH binds implies θHqH − pH = θHqL − pL.
I IRL implies θLqL − pL = 0.
I Thus we have
θHqH − pH = θHqL − pH > θLqL − pL = 0.
I So IRH can be neglected.
I This means that business customers get strictly positive utility.
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Can neglect IRH and ICL
I That ICH binds implies θHqH − pH = θHqL − pL.
I IRL implies θLqL − pL = 0.
I Thus we have
θHqH − pH = θHqL − pH > θLqL − pL = 0.
I So IRH can be neglected.
I This means that business customers get strictly positive utility.
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Can neglect IRH and ICL
I That ICH binds implies θHqH − pH = θHqL − pL.
I IRL implies θLqL − pL = 0.
I Thus we have
θHqH − pH = θHqL − pH > θLqL − pL = 0.
I So IRH can be neglected.
I This means that business customers get strictly positive utility.
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Can neglect IRH and ICL
I That ICH binds implies θHqH − pH = θHqL − pL.
I IRL implies θLqL − pL = 0.
I Thus we have
θHqH − pH = θHqL − pH > θLqL − pL = 0.
I So IRH can be neglected.
I This means that business customers get strictly positive utility.
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Can neglect IRH and ICL
I That ICH binds implies θHqH − pH = θHqL − pL.
I IRL implies θLqL − pL = 0.
I Thus we have
θHqH − pH = θHqL − pH > θLqL − pL = 0.
I So IRH can be neglected.
I This means that business customers get strictly positive utility.
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Can neglect ICL
I It can also be shown that ICL does not bind.
I Briefly: since ICH binds θH(qH − qL) = pH − pL.
I But ICL says (after rearranging) θL(qH − qL) ≤ pH − pL.
I The inequality must be strict since θH > θL.
I This means that the home bundle is strictly more attractive tohome users than is the business edition.
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Can neglect ICL
I It can also be shown that ICL does not bind.
I Briefly: since ICH binds θH(qH − qL) = pH − pL.I But ICL says (after rearranging) θL(qH − qL) ≤ pH − pL.
I The inequality must be strict since θH > θL.
I This means that the home bundle is strictly more attractive tohome users than is the business edition.
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Can neglect ICL
I It can also be shown that ICL does not bind.
I Briefly: since ICH binds θH(qH − qL) = pH − pL.I But ICL says (after rearranging) θL(qH − qL) ≤ pH − pL.
I The inequality must be strict since θH > θL.
I This means that the home bundle is strictly more attractive tohome users than is the business edition.
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Can neglect ICL
I It can also be shown that ICL does not bind.
I Briefly: since ICH binds θH(qH − qL) = pH − pL.I But ICL says (after rearranging) θL(qH − qL) ≤ pH − pL.
I The inequality must be strict since θH > θL.
I This means that the home bundle is strictly more attractive tohome users than is the business edition.
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qH is the set at the efficient level
I Now we will show that the chosen qH is q∗H—i.e. whereC ′(qH) = θH just like in the first order discrimination case.
I This implies that the quality offered to B-types is sociallyoptimal.
I Suppose that the optimal qH has C ′(qH) < θH .I The firm could change qH to qH + ∆, and increase pH topH + ∆θH without violating ICH, IRH, or ICL.
I When ∆ is small, the change in the firm’s profits isapproximately (1− α)∆(θH − C ′(qH)) > 0.
I Thus, original qH was not optimal.
I Similarly, if C ′(qH) > θH : The firm can reduce qH to qH −∆,provided it cuts its price for H by at least ∆θH .
I When ∆ is small, the change in the firm’s profits isapproximately ∆(C ′(qH)− θH) > 0
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qH is the set at the efficient level
I Now we will show that the chosen qH is q∗H—i.e. whereC ′(qH) = θH just like in the first order discrimination case.
I This implies that the quality offered to B-types is sociallyoptimal.
I Suppose that the optimal qH has C ′(qH) < θH .
I The firm could change qH to qH + ∆, and increase pH topH + ∆θH without violating ICH, IRH, or ICL.
I When ∆ is small, the change in the firm’s profits isapproximately (1− α)∆(θH − C ′(qH)) > 0.
I Thus, original qH was not optimal.
I Similarly, if C ′(qH) > θH : The firm can reduce qH to qH −∆,provided it cuts its price for H by at least ∆θH .
I When ∆ is small, the change in the firm’s profits isapproximately ∆(C ′(qH)− θH) > 0
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qH is the set at the efficient level
I Now we will show that the chosen qH is q∗H—i.e. whereC ′(qH) = θH just like in the first order discrimination case.
I This implies that the quality offered to B-types is sociallyoptimal.
I Suppose that the optimal qH has C ′(qH) < θH .I The firm could change qH to qH + ∆, and increase pH topH + ∆θH without violating ICH, IRH, or ICL.
I When ∆ is small, the change in the firm’s profits isapproximately (1− α)∆(θH − C ′(qH)) > 0.
I Thus, original qH was not optimal.
I Similarly, if C ′(qH) > θH : The firm can reduce qH to qH −∆,provided it cuts its price for H by at least ∆θH .
I When ∆ is small, the change in the firm’s profits isapproximately ∆(C ′(qH)− θH) > 0
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qH is the set at the efficient level
I Now we will show that the chosen qH is q∗H—i.e. whereC ′(qH) = θH just like in the first order discrimination case.
I This implies that the quality offered to B-types is sociallyoptimal.
I Suppose that the optimal qH has C ′(qH) < θH .I The firm could change qH to qH + ∆, and increase pH topH + ∆θH without violating ICH, IRH, or ICL.
I When ∆ is small, the change in the firm’s profits isapproximately (1− α)∆(θH − C ′(qH)) > 0.
I Thus, original qH was not optimal.
I Similarly, if C ′(qH) > θH : The firm can reduce qH to qH −∆,provided it cuts its price for H by at least ∆θH .
I When ∆ is small, the change in the firm’s profits isapproximately ∆(C ′(qH)− θH) > 0
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qH is the set at the efficient level
I Now we will show that the chosen qH is q∗H—i.e. whereC ′(qH) = θH just like in the first order discrimination case.
I This implies that the quality offered to B-types is sociallyoptimal.
I Suppose that the optimal qH has C ′(qH) < θH .I The firm could change qH to qH + ∆, and increase pH topH + ∆θH without violating ICH, IRH, or ICL.
I When ∆ is small, the change in the firm’s profits isapproximately (1− α)∆(θH − C ′(qH)) > 0.
I Thus, original qH was not optimal.
I Similarly, if C ′(qH) > θH : The firm can reduce qH to qH −∆,provided it cuts its price for H by at least ∆θH .
I When ∆ is small, the change in the firm’s profits isapproximately ∆(C ′(qH)− θH) > 0
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qH is the set at the efficient level
I Now we will show that the chosen qH is q∗H—i.e. whereC ′(qH) = θH just like in the first order discrimination case.
I This implies that the quality offered to B-types is sociallyoptimal.
I Suppose that the optimal qH has C ′(qH) < θH .I The firm could change qH to qH + ∆, and increase pH topH + ∆θH without violating ICH, IRH, or ICL.
I When ∆ is small, the change in the firm’s profits isapproximately (1− α)∆(θH − C ′(qH)) > 0.
I Thus, original qH was not optimal.
I Similarly, if C ′(qH) > θH : The firm can reduce qH to qH −∆,provided it cuts its price for H by at least ∆θH .
I When ∆ is small, the change in the firm’s profits isapproximately ∆(C ′(qH)− θH) > 0
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qH is the set at the efficient level
I Now we will show that the chosen qH is q∗H—i.e. whereC ′(qH) = θH just like in the first order discrimination case.
I This implies that the quality offered to B-types is sociallyoptimal.
I Suppose that the optimal qH has C ′(qH) < θH .I The firm could change qH to qH + ∆, and increase pH topH + ∆θH without violating ICH, IRH, or ICL.
I When ∆ is small, the change in the firm’s profits isapproximately (1− α)∆(θH − C ′(qH)) > 0.
I Thus, original qH was not optimal.
I Similarly, if C ′(qH) > θH : The firm can reduce qH to qH −∆,provided it cuts its price for H by at least ∆θH .
I When ∆ is small, the change in the firm’s profits isapproximately ∆(C ′(qH)− θH) > 0
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Optimal prices
I Now we can set about characterising the optimal prices.
I Since IRL binds, we know that pL = θLqL.
I Since ICH binds, we know that θHqH − pH = θHqL − pL, orequivalently, that pH = pL + θH(q∗H − qL).
I Combining these two statements: pH = θLqL + θH(q∗H − qL).
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Optimal prices
I Now we can set about characterising the optimal prices.
I Since IRL binds, we know that pL = θLqL.
I Since ICH binds, we know that θHqH − pH = θHqL − pL, orequivalently, that pH = pL + θH(q∗H − qL).
I Combining these two statements: pH = θLqL + θH(q∗H − qL).
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Optimal prices
I Now we can set about characterising the optimal prices.
I Since IRL binds, we know that pL = θLqL.
I Since ICH binds, we know that θHqH − pH = θHqL − pL, orequivalently, that pH = pL + θH(q∗H − qL).
I Combining these two statements: pH = θLqL + θH(q∗H − qL).
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Optimal prices
I Now we can set about characterising the optimal prices.
I Since IRL binds, we know that pL = θLqL.
I Since ICH binds, we know that θHqH − pH = θHqL − pL, orequivalently, that pH = pL + θH(q∗H − qL).
I Combining these two statements: pH = θLqL + θH(q∗H − qL).
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Firm’s objective
I The firm’s objective is
maxqL,pL,qH ,pH
α(pL − C(qL)) + (1− α)(pH − C(qH)).
I Substituting in the material we just derived (Note: sinceqH = q∗H , we only need to worry about the choice of qL.):
maxqL
α(θLqL−C(qL))+(1−α) [θLqL + θH(q∗H − qL)− C(q∗H)] .
I We can easily calculate the qL that maximises this bydifferentiating:
α[θL − C ′(qL)
]+ (1− α) [θL − θH ] = 0
I Rearranging: C ′(qL) = θL − 1−αα [θH − θL] < θL
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Firm’s objective
I The firm’s objective is
maxqL,pL,qH ,pH
α(pL − C(qL)) + (1− α)(pH − C(qH)).
I Substituting in the material we just derived (Note: sinceqH = q∗H , we only need to worry about the choice of qL.):
maxqL
α(θLqL−C(qL))+(1−α) [θLqL + θH(q∗H − qL)− C(q∗H)] .
I We can easily calculate the qL that maximises this bydifferentiating:
α[θL − C ′(qL)
]+ (1− α) [θL − θH ] = 0
I Rearranging: C ′(qL) = θL − 1−αα [θH − θL] < θL
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Firm’s objective
I The firm’s objective is
maxqL,pL,qH ,pH
α(pL − C(qL)) + (1− α)(pH − C(qH)).
I Substituting in the material we just derived (Note: sinceqH = q∗H , we only need to worry about the choice of qL.):
maxqL
α(θLqL−C(qL))+(1−α) [θLqL + θH(q∗H − qL)− C(q∗H)] .
I We can easily calculate the qL that maximises this bydifferentiating:
α[θL − C ′(qL)
]+ (1− α) [θL − θH ] = 0
I Rearranging: C ′(qL) = θL − 1−αα [θH − θL] < θL
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Firm’s objective
I The firm’s objective is
maxqL,pL,qH ,pH
α(pL − C(qL)) + (1− α)(pH − C(qH)).
I Substituting in the material we just derived (Note: sinceqH = q∗H , we only need to worry about the choice of qL.):
maxqL
α(θLqL−C(qL))+(1−α) [θLqL + θH(q∗H − qL)− C(q∗H)] .
I We can easily calculate the qL that maximises this bydifferentiating:
α[θL − C ′(qL)
]+ (1− α) [θL − θH ] = 0
I Rearranging: C ′(qL) = θL − 1−αα [θH − θL]
< θL
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Firm’s objective
I The firm’s objective is
maxqL,pL,qH ,pH
α(pL − C(qL)) + (1− α)(pH − C(qH)).
I Substituting in the material we just derived (Note: sinceqH = q∗H , we only need to worry about the choice of qL.):
maxqL
α(θLqL−C(qL))+(1−α) [θLqL + θH(q∗H − qL)− C(q∗H)] .
I We can easily calculate the qL that maximises this bydifferentiating:
α[θL − C ′(qL)
]+ (1− α) [θL − θH ] = 0
I Rearranging: C ′(qL) = θL − 1−αα [θH − θL] < θL
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Discussion of the model
I The name of the game is to separate clients into groups andmilk each group for as much as possible.
I The monopolist can squeeze more profit from high valuecustomers, who will pay more for a given increase in quality.
I But they can’t squeeze too hard—otherwise high valueconsumers will just buy the cheap product.
I Solution: deliberately degrade the usefulness of the budgetproduct to ensure that high-value customers refuse to buy it.
I Then the firm can charge a high price for the premiumproduct, without worrying about customers switching tocheaper versions.
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Discussion of the model
I The name of the game is to separate clients into groups andmilk each group for as much as possible.
I The monopolist can squeeze more profit from high valuecustomers, who will pay more for a given increase in quality.
I But they can’t squeeze too hard—otherwise high valueconsumers will just buy the cheap product.
I Solution: deliberately degrade the usefulness of the budgetproduct to ensure that high-value customers refuse to buy it.
I Then the firm can charge a high price for the premiumproduct, without worrying about customers switching tocheaper versions.
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Discussion of the model
I The name of the game is to separate clients into groups andmilk each group for as much as possible.
I The monopolist can squeeze more profit from high valuecustomers, who will pay more for a given increase in quality.
I But they can’t squeeze too hard—otherwise high valueconsumers will just buy the cheap product.
I Solution: deliberately degrade the usefulness of the budgetproduct to ensure that high-value customers refuse to buy it.
I Then the firm can charge a high price for the premiumproduct, without worrying about customers switching tocheaper versions.
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Discussion of the model
I The name of the game is to separate clients into groups andmilk each group for as much as possible.
I The monopolist can squeeze more profit from high valuecustomers, who will pay more for a given increase in quality.
I But they can’t squeeze too hard—otherwise high valueconsumers will just buy the cheap product.
I Solution: deliberately degrade the usefulness of the budgetproduct to ensure that high-value customers refuse to buy it.
I Then the firm can charge a high price for the premiumproduct, without worrying about customers switching tocheaper versions.
![Page 87: Industrial Organisation Off and On the Internet](https://reader033.vdocument.in/reader033/viewer/2022060115/5579f94cd8b42abc2e8b4e40/html5/thumbnails/87.jpg)
Discussion of the model
I The name of the game is to separate clients into groups andmilk each group for as much as possible.
I The monopolist can squeeze more profit from high valuecustomers, who will pay more for a given increase in quality.
I But they can’t squeeze too hard—otherwise high valueconsumers will just buy the cheap product.
I Solution: deliberately degrade the usefulness of the budgetproduct to ensure that high-value customers refuse to buy it.
I Then the firm can charge a high price for the premiumproduct, without worrying about customers switching tocheaper versions.
![Page 88: Industrial Organisation Off and On the Internet](https://reader033.vdocument.in/reader033/viewer/2022060115/5579f94cd8b42abc2e8b4e40/html5/thumbnails/88.jpg)
Discussion of the model
I The name of the game is to separate clients into groups andmilk each group for as much as possible.
I The monopolist can squeeze more profit from high valuecustomers, who will pay more for a given increase in quality.
I But they can’t squeeze too hard—otherwise high valueconsumers will just buy the cheap product.
I Solution: deliberately degrade the usefulness of the budgetproduct to ensure that high-value customers refuse to buy it.
I Then the firm can charge a high price for the premiumproduct, without worrying about customers switching tocheaper versions.
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Examples
£2/kg£2/kg £10/kg £18/kg
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Examples
It is not because of the few thousand francs which would have tobe spent to put a roof over the third-class carriage or to upholsterthe third-class seats that some company or other has opencarriages with wooden benches. . . What the company is trying todo is prevent the passengers who can pay the second-class farefrom travelling third class; it hits the poor, not because it wants tohurt them, but to frighten the rich. . . (Ekelund [1970])
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I Note that the distortion of qL away from its optimal level is amarket failure.
I However, it does not follow that the optimal policy is toprevent firms from second degree discrimination. . .
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I Note that the distortion of qL away from its optimal level is amarket failure.
I However, it does not follow that the optimal policy is toprevent firms from second degree discrimination. . .
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Second-degree discrimination & social welfareI What will the firm do if it cannot price discriminate?
I Will provide either q∗H at price θHq∗H , or q∗L at price θLq
∗L.
I In the efficient allocation, social welfare is
α [θLq∗L − C(q∗L)] + (1− α) [θHq∗H − C(q∗H)] .
(we can ignore the ps which simply move surplus around).I In the second order price discrimination case, social welfare is
α [θLqL − C(qL)] + (1− α) [θHq∗H − C(q∗H)] .
I If the firm offers only q∗H , social welfare is
(1− α) [θHq∗H − C(q∗H)] .
Thus social welfare falls.I If the firm offers only q∗L, social welfare is
α [θLq∗L − C(q∗L)] + (1− α) [θHq∗L − C(q∗L)] ,
so that welfare may fall or increase relative to second-orderPD.
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Second-degree discrimination & social welfareI What will the firm do if it cannot price discriminate?I Will provide either q∗H at price θHq
∗H , or q∗L at price θLq
∗L.
I In the efficient allocation, social welfare is
α [θLq∗L − C(q∗L)] + (1− α) [θHq∗H − C(q∗H)] .
(we can ignore the ps which simply move surplus around).I In the second order price discrimination case, social welfare is
α [θLqL − C(qL)] + (1− α) [θHq∗H − C(q∗H)] .
I If the firm offers only q∗H , social welfare is
(1− α) [θHq∗H − C(q∗H)] .
Thus social welfare falls.I If the firm offers only q∗L, social welfare is
α [θLq∗L − C(q∗L)] + (1− α) [θHq∗L − C(q∗L)] ,
so that welfare may fall or increase relative to second-orderPD.
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Second-degree discrimination & social welfareI What will the firm do if it cannot price discriminate?I Will provide either q∗H at price θHq
∗H , or q∗L at price θLq
∗L.
I In the efficient allocation, social welfare is
α [θLq∗L − C(q∗L)] + (1− α) [θHq∗H − C(q∗H)] .
(we can ignore the ps which simply move surplus around).
I In the second order price discrimination case, social welfare is
α [θLqL − C(qL)] + (1− α) [θHq∗H − C(q∗H)] .
I If the firm offers only q∗H , social welfare is
(1− α) [θHq∗H − C(q∗H)] .
Thus social welfare falls.I If the firm offers only q∗L, social welfare is
α [θLq∗L − C(q∗L)] + (1− α) [θHq∗L − C(q∗L)] ,
so that welfare may fall or increase relative to second-orderPD.
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Second-degree discrimination & social welfareI What will the firm do if it cannot price discriminate?I Will provide either q∗H at price θHq
∗H , or q∗L at price θLq
∗L.
I In the efficient allocation, social welfare is
α [θLq∗L − C(q∗L)] + (1− α) [θHq∗H − C(q∗H)] .
(we can ignore the ps which simply move surplus around).I In the second order price discrimination case, social welfare is
α [θLqL − C(qL)] + (1− α) [θHq∗H − C(q∗H)] .
I If the firm offers only q∗H , social welfare is
(1− α) [θHq∗H − C(q∗H)] .
Thus social welfare falls.I If the firm offers only q∗L, social welfare is
α [θLq∗L − C(q∗L)] + (1− α) [θHq∗L − C(q∗L)] ,
so that welfare may fall or increase relative to second-orderPD.
![Page 97: Industrial Organisation Off and On the Internet](https://reader033.vdocument.in/reader033/viewer/2022060115/5579f94cd8b42abc2e8b4e40/html5/thumbnails/97.jpg)
Second-degree discrimination & social welfareI What will the firm do if it cannot price discriminate?I Will provide either q∗H at price θHq
∗H , or q∗L at price θLq
∗L.
I In the efficient allocation, social welfare is
α [θLq∗L − C(q∗L)] + (1− α) [θHq∗H − C(q∗H)] .
(we can ignore the ps which simply move surplus around).I In the second order price discrimination case, social welfare is
α [θLqL − C(qL)] + (1− α) [θHq∗H − C(q∗H)] .
I If the firm offers only q∗H , social welfare is
(1− α) [θHq∗H − C(q∗H)] .
Thus social welfare falls.
I If the firm offers only q∗L, social welfare is
α [θLq∗L − C(q∗L)] + (1− α) [θHq∗L − C(q∗L)] ,
so that welfare may fall or increase relative to second-orderPD.
![Page 98: Industrial Organisation Off and On the Internet](https://reader033.vdocument.in/reader033/viewer/2022060115/5579f94cd8b42abc2e8b4e40/html5/thumbnails/98.jpg)
Second-degree discrimination & social welfareI What will the firm do if it cannot price discriminate?I Will provide either q∗H at price θHq
∗H , or q∗L at price θLq
∗L.
I In the efficient allocation, social welfare is
α [θLq∗L − C(q∗L)] + (1− α) [θHq∗H − C(q∗H)] .
(we can ignore the ps which simply move surplus around).I In the second order price discrimination case, social welfare is
α [θLqL − C(qL)] + (1− α) [θHq∗H − C(q∗H)] .
I If the firm offers only q∗H , social welfare is
(1− α) [θHq∗H − C(q∗H)] .
Thus social welfare falls.I If the firm offers only q∗L, social welfare is
α [θLq∗L − C(q∗L)] + (1− α) [θHq∗L − C(q∗L)] ,
so that welfare may fall or increase relative to second-orderPD.
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More current examples
I In fact, when one thinks about it, there are similar-lookingcases in many information markets:
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More current examples
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More current examples
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More current examples
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More current examples
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More current examples
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Outline
Price discrimination: from assumptions to policy statements
Assumptions and applicability
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Assumptions, assumptions. . .
I But these examples are a little different to the ones consideredbefore:
I Cost to MS of “surprising” a customer by giving them theprofessional, rather than home edition of Windows is basicallyzero.
I Corresponds to C ′(q) = 0, C ′′(q) = 0—which is contrary toour assumptions.
I When we try to put this into the model things break down.Let’s see why. . .
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Assumptions, assumptions. . .
I But these examples are a little different to the ones consideredbefore:
I Cost to MS of “surprising” a customer by giving them theprofessional, rather than home edition of Windows is basicallyzero.
I Corresponds to C ′(q) = 0, C ′′(q) = 0—which is contrary toour assumptions.
I When we try to put this into the model things break down.Let’s see why. . .
![Page 108: Industrial Organisation Off and On the Internet](https://reader033.vdocument.in/reader033/viewer/2022060115/5579f94cd8b42abc2e8b4e40/html5/thumbnails/108.jpg)
Assumptions, assumptions. . .
I But these examples are a little different to the ones consideredbefore:
I Cost to MS of “surprising” a customer by giving them theprofessional, rather than home edition of Windows is basicallyzero.
I Corresponds to C ′(q) = 0, C ′′(q) = 0—which is contrary toour assumptions.
I When we try to put this into the model things break down.Let’s see why. . .
![Page 109: Industrial Organisation Off and On the Internet](https://reader033.vdocument.in/reader033/viewer/2022060115/5579f94cd8b42abc2e8b4e40/html5/thumbnails/109.jpg)
Graphical treatment (assuming α = 1/2)
Price
QuantityQuality
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Graphical treatment (assuming α = 1/2)
Price
QuantityQuality
θH
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Graphical treatment (assuming α = 1/2)
Price
Willingness to pay
QuantityQuality
θH
qH
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Graphical treatment (assuming α = 1/2)
Price
QuantityQuality
C’(q)
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Graphical treatment (assuming α = 1/2)
Price
QuantityQuality
C’(q)Cost of production
qH
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Graphical treatment (assuming α = 1/2)
Price
QuantityQuality
θH
θL
C’(q)
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First degree discrimination
Price
QuantityQuality
θH
qHqL
θL
C’(q)
* *
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Graphical treatment
Price
QuantityQuality
θH
qHqL
C’(q)CS of high types from buyinglow quality good
qLθL=
pL
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Graphical treatment
Price
QuantityQuality
θH
qHqL
C’(q)CS of high types from buyinglow quality good
qLθL=
pL
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Graphical treatment
Price
QuantityQuality
θH
qHqL
C’(q)
qLθL=
pL
pHqH
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Graphical treatment
Price
QuantityQuality
θH
qHqL
C’(q)CS of high types from buyinghigh quality good
qLθL=
pL
pHqH
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Graphical treatment
Price
QuantityQuality
θH
qHqL qL+Δ
C’(q)
qLθL=
pL
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Graphical treatment
Price
QuantityQuality
θH
qHqL qL+Δ
C’(q)Loss (must reduce pH to maintain ICH)
qLθL=
pL
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Graphical treatment
Price
QuantityQuality
θH
qHqL qL+Δ
C’(q)Loss (must reduce pH to maintain ICH)
Loss (higher q is moreexpensive to produce)
Gain (can charge moreto low type consumers)
qLθL=
pL
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Graphical treatment
Price
QuantityQuality
θH
qH
C’(q)
qL qL* *
qLθL=
pL
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Constant marginal cost
Price
QuantityQuality
θH
C’(q)
qLθL=
pL
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What goes wrong?
Price
QuantityQuality
θH
C’(q)
qL qL+Δ
qLθL=
pL
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What goes wrong? (i)
Price
QuantityQuality
θH
C’(q)
qL qL+ΔqL qL+Δ
qLθL=
pL
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What goes wrong? (ii)
Price
QuantityQuality
θH
C’(q)
qL qL+ΔqL qL+Δ
qLθL=
pL
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Declining marginal willingness to pay.
Price
QuantityQuality
θH
θL
C’(q)
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Declining marginal willingness to pay.
Price
QuantityQuality
θH
Δq Δq
Declining ΔWTP
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First degree descrimination.
Price
QuantityQuality
θH
qHqL
θL
C’(q)
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Profit effect of a quality increase.
θH
qH
θL
C’(q)
qL qL* *
Price Loss (Need to lower pH to maintain ICH)
Gain (Can charge more to low value consumers)
QuantityQuality
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Other assumptions
In a similar manner, one can relax other assumptions e.g.:
I Oligopoly suppliers.
I Many consumer types.
I Non-continuous q.
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Summary
I Social science is about understanding society.
I That, at least in part, means trying to understand thefundamental forces that drive social phenomena.
I Often, behaviour is fundamentally unchanged by newtechnology. Looking into the past can offer hints on how tounderstand and interpret the present.
I Moreover, the result of linking related phenomena is often aninsight that exceeds the sum of its parts.
I Sometimes the process works backwards: new contexts cangenerate insights into old puzzles—e.g. two-sided markets.
I A key ingredient in making these links is an understanding ofthe assumptions upon which alternative conceptualisations arepredicated.
![Page 134: Industrial Organisation Off and On the Internet](https://reader033.vdocument.in/reader033/viewer/2022060115/5579f94cd8b42abc2e8b4e40/html5/thumbnails/134.jpg)
Summary
I Social science is about understanding society.
I That, at least in part, means trying to understand thefundamental forces that drive social phenomena.
I Often, behaviour is fundamentally unchanged by newtechnology. Looking into the past can offer hints on how tounderstand and interpret the present.
I Moreover, the result of linking related phenomena is often aninsight that exceeds the sum of its parts.
I Sometimes the process works backwards: new contexts cangenerate insights into old puzzles—e.g. two-sided markets.
I A key ingredient in making these links is an understanding ofthe assumptions upon which alternative conceptualisations arepredicated.
![Page 135: Industrial Organisation Off and On the Internet](https://reader033.vdocument.in/reader033/viewer/2022060115/5579f94cd8b42abc2e8b4e40/html5/thumbnails/135.jpg)
Summary
I Social science is about understanding society.
I That, at least in part, means trying to understand thefundamental forces that drive social phenomena.
I Often, behaviour is fundamentally unchanged by newtechnology. Looking into the past can offer hints on how tounderstand and interpret the present.
I Moreover, the result of linking related phenomena is often aninsight that exceeds the sum of its parts.
I Sometimes the process works backwards: new contexts cangenerate insights into old puzzles—e.g. two-sided markets.
I A key ingredient in making these links is an understanding ofthe assumptions upon which alternative conceptualisations arepredicated.
![Page 136: Industrial Organisation Off and On the Internet](https://reader033.vdocument.in/reader033/viewer/2022060115/5579f94cd8b42abc2e8b4e40/html5/thumbnails/136.jpg)
Summary
I Social science is about understanding society.
I That, at least in part, means trying to understand thefundamental forces that drive social phenomena.
I Often, behaviour is fundamentally unchanged by newtechnology. Looking into the past can offer hints on how tounderstand and interpret the present.
I Moreover, the result of linking related phenomena is often aninsight that exceeds the sum of its parts.
I Sometimes the process works backwards: new contexts cangenerate insights into old puzzles—e.g. two-sided markets.
I A key ingredient in making these links is an understanding ofthe assumptions upon which alternative conceptualisations arepredicated.
![Page 137: Industrial Organisation Off and On the Internet](https://reader033.vdocument.in/reader033/viewer/2022060115/5579f94cd8b42abc2e8b4e40/html5/thumbnails/137.jpg)
Summary
I Social science is about understanding society.
I That, at least in part, means trying to understand thefundamental forces that drive social phenomena.
I Often, behaviour is fundamentally unchanged by newtechnology. Looking into the past can offer hints on how tounderstand and interpret the present.
I Moreover, the result of linking related phenomena is often aninsight that exceeds the sum of its parts.
I Sometimes the process works backwards: new contexts cangenerate insights into old puzzles—e.g. two-sided markets.
I A key ingredient in making these links is an understanding ofthe assumptions upon which alternative conceptualisations arepredicated.
![Page 138: Industrial Organisation Off and On the Internet](https://reader033.vdocument.in/reader033/viewer/2022060115/5579f94cd8b42abc2e8b4e40/html5/thumbnails/138.jpg)
Summary
I Social science is about understanding society.
I That, at least in part, means trying to understand thefundamental forces that drive social phenomena.
I Often, behaviour is fundamentally unchanged by newtechnology. Looking into the past can offer hints on how tounderstand and interpret the present.
I Moreover, the result of linking related phenomena is often aninsight that exceeds the sum of its parts.
I Sometimes the process works backwards: new contexts cangenerate insights into old puzzles—e.g. two-sided markets.
I A key ingredient in making these links is an understanding ofthe assumptions upon which alternative conceptualisations arepredicated.
![Page 139: Industrial Organisation Off and On the Internet](https://reader033.vdocument.in/reader033/viewer/2022060115/5579f94cd8b42abc2e8b4e40/html5/thumbnails/139.jpg)
Summary
I Social science is about understanding society.
I That, at least in part, means trying to understand thefundamental forces that drive social phenomena.
I Often, behaviour is fundamentally unchanged by newtechnology. Looking into the past can offer hints on how tounderstand and interpret the present.
I Moreover, the result of linking related phenomena is often aninsight that exceeds the sum of its parts.
I Sometimes the process works backwards: new contexts cangenerate insights into old puzzles—e.g. two-sided markets.
I A key ingredient in making these links is an understanding ofthe assumptions upon which alternative conceptualisations arepredicated.