At the other extreme from perfect competition, some firms exist in conditions of monopoly or near-monopoly and thus have consider- able control over prices.
Monopoly pricing
A monopoly is literally defined as one seller, and monopoly power is maintained by ensuring that barriers to entry into the industry are maintained. In the case of one seller the firm’s demand curve is the same as the industry demand curve. Because of this, the monopolist is in a position to be a price maker.
There are examples of near-monopolies in the leisure and tourism sector. For example, there are only two car ferry services to the Isle of Wight (an island off the South coast of the UK) and these oper- ate on different routes, thus giving each operator some control over price. Unique tourist attractions also have some degree of monop- oly power. There is no similar attraction to the London Eye in the UK, although to some extent the main visitor attractions in London all compete with each other. Manchester United Football Club, like many other sporting clubs, is unique. Table 6.1 shows typical demand data for a unique attraction. It demonstrates the trade-off that a monopoly producer faces – it can raise prices but as it does
Table 6.1 Monopoly attraction demand data Price (£) Quantity demanded
(visitors/hour) Total revenuea Marginal revenueb
10 0 0
9 10 90 9
8 20 160 7
7 30 210 5
6 40 240 3
5 50 250 1
4 60 240 1
3 70 210 3
2 80 160 5
1 90 90 7
0 100 0 9
aTotal revenue: price quantity sold.
bMarginal revenue: the extra revenue gained from attracting one extra customer (TR ÷ Q), where TR total revenue and Q quantity.
so demand falls (but does not disappear as would be the case under perfect competition). So the question that arises for a monopolist is what is the best price to charge? The answer is that price that will maximize total revenue.
The price that maximizes total revenue for this organization is one of £5 when total revenue of £250 per hour is generated. This is illustrated in Figure 6.2. In Figure 6.2A, D represents the firm’s demand curve using the data from Table 6.1. In Figure 6.2B, TR represents the firm’s total revenue curve. This is found by multiply- ing quantity sold at each price. Price £5 generates total revenue of
(A)
(B)
Price (£)Total revenue (£/hour)
10
250
200
150
100
50
0 20 40
Demand (visitors per hour)
60 80 100
X
Y
D Z
TR 8
6 5 4
2
0 20 40 60 80 100
Figure 6.2 (A) Demand and (B) revenue-maximizing price for monopolist.
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Market structure and pricing£250 per hour, whilst a higher price of £8 or a lower price of £2 causes total revenue to fall to £160.
This confirms the relationship between changes in price, changes in total revenue and elasticity of demand discussed in Chapter 4.
Where demand is inelastic, a rise in price will cause an increase in total revenue. Where demand is elastic, a rise in price will cause a fall in total revenue. Profit maximization therefore occurs where demand elasticity is 1. In Figure 6.2 the demand curve is elastic in the range X to Y, inelastic in the range Y to Z and has unit elasticity at point Y.
To summarize, monopolists can choose a price resulting in high profits, without fear of loss of market share to competitors. The actual price chosen will reflect both demand conditions and the firm’s cost conditions. Exhibit 6.1 shows how top UK football clubs can exploit their market position but how difficult market conditions can reduce their monopoly power.
Price-discriminating monopolist/yield management
Some firms sell the same goods or services at different prices to dif- ferent groups of people. For example, BA return fares from London to New York (2011) are: £5474 (first class), £2184 (club class), £937 (premium economy), £1238 (flexible economy), £356 (restricted economy), £123.80 (staff 10 per cent standby) and £0 tax (staff yearly free standby/holders of airmiles or frequent-flyer miles).
Exhibit 6.1 Chelsea fans: sold out
Price increases for season tickets at Chelsea Football Club for the 1998–1999 season were in some cases as high as 47 per cent as against inflation of around 2.5 per cent in the UK economy. This meant that the cheapest season ticket for supporters rose to £525, while the most expensive rose to £1250.
Top premier clubs find themselves in monopoly positions. Stadiums are full to capacity and price increases do not lead fans to choose alternative products elsewhere. Nearby Fulham or Arsenal do not offer alternative football for Chelsea fans in the way that different brands of beer can be seen as substitutes.
However, conditions of a deep economic recession mean that even near- monopoly organizations have to consider their pricing strategies more carefully. For the 2010–2011 season Chelsea Football Club announced that their season ticket prices would rise for the first time since July 2005.
The increases, which follow a 4-year price freeze, saw the cheapest season ticket in the family stand priced at £550 and the most expensive excluding hospitality a West Upper Stand ticket priced at £1210. This means that between 1998 and 2010 the cheapest season ticket rose in price by only £25 whilst the most expensive fell by £40.
Source: Adapted from The Guardian and FootballTadeDirectory.com by the author.
In fact, BA is not a monopolist since there is much competition on this route. It should also be recognized that the fare differential for club and first-class passengers is not strictly price discrimination since these represent different services with different costs. But since all economy-class passengers receive an identical service, why should BA charge different prices and why do passengers accept different prices? The answer is that by price discrimination companies can increase their profits by charging different prices according to how much different market segments are prepared to pay.
The conditions for price discrimination to take place are as follows:
l The product cannot be resold. If this were not the case,
customers buying at the low price would sell to customers at the high price and the system would break down. Services therefore provide good conditions for price discrimination.
l There must be market imperfections (otherwise firms would all compete to the lowest price).
l The seller must be able to identify different market segments with different demand elasticities (e.g. age groups and different times of use).
Figure 6.3 illustrates a typical demand curve for economy-class travel. If a single price of £500 is charged as in Figure 6.3A, then 250 seats are sold and total revenue is £125,000. Figure 6.3B shows a sit- uation in which three prices are charged. One hundred seats are sold at £800, the next 150 seats are sold at £500 and the next 150 seats are sold at £200, producing a total revenue of £185,000, an increase of £60,000 over the single price situation.
Airlines must consider the behaviour of costs when price discrimi- nating. Once the decision has been taken to run a scheduled service, marginal costs are low up until the aircraft capacity, when there is a sudden large jump. Airlines are able to discriminate by applying travel restrictions to differently priced tickets. So, for example, full- fare economy tickets are fully refundable and flights may be changed at no cost. Cheaper tickets are non-refundable and have advance purchase and travel duration restrictions.
Yield management is a sophisticated form of price discrimina- tion. Hamzaee and Vasigh (1997) discuss a model for establishing the optimal allocation of available seats to different classes of air- fare. Computer technology is able to identify patterns of demand for a particular product and compare it with its supply. A request for a hotel reservation or an airline ticket will result in the system suggest- ing a price that will maximize the yield for a particular flight or day’s reservations. So for budget airlines, for example, seats on a Friday or Sunday night or in school holidays tend to be expensive whilst a seat to the same destination on a Tuesday morning would be much
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Market structure and pricingcheaper. Exhibit 6.2 shows how orchestras are hoping to exploit this system to maximize revenue at concerts.