Other Sales Strategies:

a) Two-part Tariff Pricing:

The consumer pays a fixed (access) fee for service, plus a variable charge per unit purchased. Ex) utilities (electricity and gas), amusement parks and theme parks, sports clubs (racquet courts, aerobic classes, golf clubs etc).

b) Tying and Bundling:

• Tying: a seller’s conditioning the buy of one product on the purchase of another.

Technological ties: specific plug-in interface may be hard to copy or actually protected from copying by IPR. Example- ink-jet printers

Contractual ties: consumer is bound by contract to consume both products from the same Source. Example Harley-Davidson Motorcycles.

Welfare Issues in Monopoly:

The major concern is that monopoly misallocates resources by producing the “wrong” amount of a good, where price does not equal marginal cost.

Suppose we are given the demand function as P(Q) = A − bQ , and the cost is fixed at c. With this information we are necessary to solve the following questions:

Determinants of DWL:

DWL = 1/2dP. dQ = 1/2dP. dQ.( dP/dP).(P/P).(Q/Q).(P/P)

If we assume constant costs, so that dP = Pm − c , then upon gathering terms, this is equivalent to

DWL =1/2⋅εD .Pm ⋅Qm ⋅L² where L is Lerner Index.

This suggests that the inefficiency associated with monopoly pricing is greater, the larger the Lerner index, the larger the elasticity of demand, and the larger the industry (as measured by the firm’s revenues). Nevertheless such an interpretation would be incorrect since L depends on the elasticity of demand. As ε rises a profit-maximizing monopolist responds by decreasing L.

Starting with Harberger (1954), estimates of the economy-wide loss from the exercise or market power have been calculated based on the above equation. Harberger estimated that the DWL in the manufacturing sector in U.S. was approximately 0.1% of GDP. The relatively small estimates are due to low observed values of L and his assumption that the elasticity of demand was one. Little values of L are consistent with profit maximizing if demand is relatively elastic not unity.

Cowling and Mueller (1978) observe that if a firm is a monopolist and profit maximizes, then ε_D = 1 L and the equation will be DWL = π_m/2. Their estimates based on this equation suggest that DWL could be on the order of 4% of GNP. However, the use of this assumes that all firms are monopolists, and this is clearly as unsatisfactory as assuming that L is independent of the elasticity of demand.

X-inefficiency:

A monopoly may spend “too much” on advertising, product differentiation, or investment in excess production capacity. Tullock (1967) and Posner (1975) argue that the welfare costs of monopoly include expenditures on lobbying and campaign contributions intended to obtain tariff protection, patent protection, and other preferential government treatment. In the extreme, a firm would be willing to spend an amount up to the potential monopoly profits to become a monopolist. Such rent-seeking activities would enhance the welfare costs of monopoly.

Cowling as well as Mueller considered this issue carefully. They used advertising expenditures to approximate the costs of monopolization to society. Adding these costs to their estimate of DWL, they estimated that the welfare cost of monopolization may be as high as 13 percent of GDP.

In less competitive markets there is a smaller amount of pressure on firms to use inputs efficiently. Inefficient monopolists may not be driven out of the market even in the long run. We consider this effect on costs, called X-inefficiency (by Leibenstein, 1966). If monopolization raises costs, the DWL is larger. Additionally the costs of producing the monopoly output level are higher. The important welfare point is that if increasing competition in monopolized markets would lead to reduced costs, then estimates of welfare loss based on DWL triangles such as Harberger’s will be far too low. While the controversy over the welfare cost of market power has not been resolved, it is possible to step back and make three observations. First, even a relatively small percent of GNP represents a considerable amount of resources. Second, any strategic behavior on the part of firms intended to obtain or protect their monopoly positions raises the costs of monopolization substantially. Third, in some industries, the potential gains to society from decreasing monopoly power are large.

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