chapter 8 l.
Download
Skip this Video
Loading SlideShow in 5 Seconds..
Chapter 8 PowerPoint Presentation
Download Presentation
Chapter 8

Loading in 2 Seconds...

play fullscreen
1 / 35

Chapter 8 - PowerPoint PPT Presentation


  • 209 Views
  • Uploaded on

Chapter 8 Commodity Bundling and Tie-in Sales Introduction Firms often bundle the goods that they offer Microsoft bundles Windows and Explorer Office bundles Word, Excel, PowerPoint, Access Bundled package is usually offered at a discount Bundling may increase market power

loader
I am the owner, or an agent authorized to act on behalf of the owner, of the copyrighted work described.
capcha
Download Presentation

PowerPoint Slideshow about 'Chapter 8' - Roberta


An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -
Presentation Transcript
chapter 8
Chapter 8
  • Commodity Bundling and Tie-in Sales
introduction
Introduction
  • Firms often bundle the goods that they offer
    • Microsoft bundles Windows and Explorer
    • Office bundles Word, Excel, PowerPoint, Access
  • Bundled package is usually offered at a discount
  • Bundling may increase market power
    • GE merger with Honeywell
  • Tie-in sales ties the sale of one product to the purchase of another
  • Tying may be contractual or technological
    • IBM computer card machines and computer cards
    • Kodak tie service to sales of large-scale photocopiers
    • Tie computer printers and printer cartridges
  • Why? To make money!
bundling an example
Bundling: an example

1, How much can

be charged for

Casablanca & Godzilla? $7000 & $2500 respectively

  • Two television stations offered two old Hollywood films
    • Casablanca and Son of Godzilla
  • Arbitrage is possible between the stations
  • Willingness to pay is:

2, If the films are sold

separately total

revenue is $19,000

Willingness to pay for Casablanca

Willingness to pay for Godzilla

Station A

$8,000

$2,500

Station B

$7,000

$3,000

slide4

Example on next page

Now suppose that the two films are bundled and sold as a package

How much can be charged for the package?

If the films are sold as a package total revenue is $20,000

Bundling is profitable because it exploits aggregate willingness pay

bundling an example5
Bundling: an example

Willingness to pay for Casablanca

Willingness to pay for Godzilla

Total Willingness

to pay

$10,500

$8,000

$2,500

Station A

Station B

$7,000

$3,000

$10,000

$10,000

slide6
Now Extend this example to allow for
  • costs ,

(2) mixed bundling :offering products in a bundle and separately

Suppose that there are two goods and that consumers differ in

their reservation prices for these goods

Each consumer buys exactly one unit of a good provided that price is less than her reservation price

Consumer x has reservation price px1 for good 1 and px2 for good 2

Consumer y has reservation price py1 for good 1 and py2 for good 2

Suppose that the firm sets price p1 for good 1 and price p2 for good 2

bundling another example

y

py2

x

px2

px1

py1

Bundling: another example

3, All consumers in

region B buy

only good 2

2, All consumers in

region A buy

both goods

R2

B

A

4, All consumers in

region D buy

only good 1

p2

D

C

1, Consumers

split into

four groups

p1

R1

5, All consumers in

region C buy

neither good

now consider pure bundling at some price p b consumers now split into two groups
Now consider pure bundling at some price pBConsumers now split into two groups

1, All consumers in

region E (right of PB line) buy

the bundle

R2

3, Consumers in these two black regions

can buy each good even though

their reservation price for one of

the goods is less than its

marginal cost

pB

E

F

c2

c1

pB

R1

2, All consumers in

region F(left of PB line) do not

buy the bundle

slide9
Now consider mixed bundling ( see next page)

Good 1 is sold at price p1

Good 2 is sold at price p2

The bundle is sold at price PB < P1 + P2

Consumers split into four groups: buy the bundle, buy only good 1, buy only good 2 , and buy nothing

mixed bundling

1, Consumers in this

region are willing to

buy both goods. They

buy the bundle

Mixed Bundling

5, Consumers in this

region buy only

good 2

8, In this region

consumers buy

either the bundle

or product 2

R2

pB

6, This leaves

two regions, 7&8

p2

3, Consumers in this

region buy nothing

7, In this region

consumers buy

either the bundle

or product 1

pB - p1

pB - p2

p1

R1

pB

2, Consumers in this

region also

buy the bundle

4, Consumers in this

region buy only

good 1

slide11
See next page

Consider consumer x with reservation prices p1x for product 1 and p2x for product 2

Her aggregate willingness to pay for the bundle is p1x + p2x

Consumer surplus from buying the bundle is p1x + p2x - pB

mixed bundling cont
Mixed Bundling (cont.)

5, Similarly, all consumers in

this region buy

only product 2

3, The consumer x will buy only product 1

R2

pB

p2

4, All consumers in

this region buy

only product 1

pB - p1

x

p2x

2, Consumer surplus from

buying product 1 is

p1x - p1

p1x

pB - p2

p1

pB

R1

p1x+p2x

1, Which is this

measure

mixed bundling cont13
Mixed Bundling (cont.)
  • What should a firm actually do?
  • There is no simple answer
    • mixed bundling is generally better than pure bundling
    • but bundling is not always the best strategy
  • Each case needs to be worked out on its merits
an example
An Example

Four consumers; two products; MC1 = $100, MC2 = $150

Reservation Price for Good 1

Reservation Price for Good 2

Sum of Reservation Prices

Consumer

A

$50

$450

$500

B

$250

$275

$525

$300

$220

$520

C

$50

D

$450

$500

slide15
Consider simply monopoly pricingGood 1 should be sold at $250 and Good 2 at $450. Total profit is $450 +$300 =$750.

Good 1: Marginal Cost $100

Price

Quantity

Total revenue

Profit

$450

1

$450

$350

$300

2

$400

$600

$250

$250

3

$750

$450

$50

4

$200

-$200

Good 2: Marginal Cost $150

Price

Quantity

Total revenue

Profit

$450

$450

1

$450

$300

$275

2

$200

$550

$220

3

$660

$210

$50

4

$200

-$400

now consider pure bundling

1,The highest bundle

price that can be

considered is $500

2, All four consumers will buy

the bundle and profit is

4x$500 - 4x($150 + $100)

= $1,000

Now consider purebundling

Reservation Price for Good 1

Reservation Price for Good 2

Sum of Reservation Prices

Consumer

A

$50

$450

$500

B

$250

$275

$525

$300

$220

$520

C

D

$450

$50

$500

now consider mixed bundling

1, All four consumers buy

something and profit is

$250x2 + $150x2

= $800

Now consider mixed bundling

Take the monopoly prices p1 = $250;

p2 = $450 and a bundle price pB = $500

Reservation Price for Good 1

Reservation Price for Good2

Sum of Reservation Prices

Consumer

A

$50

$450

$500

$500

B

$250

$275

$500

$525

$300

$250

$220

$520

C

$50

D

$450

$250

$500

2, Can the seller improve

on this?

1 try instead the prices p 1 450 p 2 450 and a bundle price p b 520

3, This is actually

the best that the

firm can do

1, Try instead the prices p1 = $450; p2 = $450 and a bundle price pB = $520

2, All four consumers buy and profit is $300 + $270x2 + $350 = $1,190

Reservation Price for Good 1

Reservation Price for Good 2

Sum of Reservation Prices

Consumer

A

$50

$450

$450

$500

B

$250

$275

$520

$525

$300

$220

$520

$520

C

D

$450

$450

$50

$500

bundling cont
Bundling (cont.)
  • Bundling does not always work
  • Requires that there are reasonably large differences in consumer valuations of the goods
  • What about tie-in sales?
    • “like” bundling but proportions vary
    • allows the monopolist to make supernormal profits on the tied good
    • different users charged different effective prices depending upon usage
    • facilitates price discrimination by making buyers reveal their demands
tie in sales
Tie-in Sales
  • Suppose that a firm offers a specialized product – a camera? – that uses highly specialized film cartridges
  • Then it has effectively tied the sales of film cartridges to the purchase of the camera
    • this is actually what has happened with computer printers and ink cartridges
  • How should it price the camera and film?
    • suppose that marginal costs of the film and of making the camera are zero (to keep things simple)
    • suppose also that there are two types of consumer: high-demand and low-demand

See example in next page

Suppose that the firm leases the product for $72 per period

tie in sales21

3, Profit is $72 from each type of consumer

So this gives profit of $144 per pair of high-and low-demand consumers

Tie-In Sales

Low-Demand

Consumers

High-Demand

Consumers

4, Is this the best that

the firm can do?

Demand: P = 12 - Q

Demand: P = 16 - Q

$

$

$16

$12

2, Low-demand consumers are willing to buy 12 units

$128

1,High-demand consumers buy 16 units

$72

16

12

Quantity

Quantity

tie in sales22

1,Suppose that the firm sets a price of $2 per unit

7, Profit is $70 from each low-demand consumer: $50 + $20

and $78 from each high-demand consumer: $50 + $28

giving $148 per pair of high-demand and low-demand

6, So the firm can set a lease charge of $50 to each type of consumer: it cannot discriminate

Tie-In Sales

Low-Demand

Consumers

Demand: P = 12 - Q

Demand: P = 16 - Q

$

$

$16

$12

Demand: P = 12 - Q

4, Consumer surplus for high-demand consumers is $98

5, Consumer surplus for low-demand consumers is $50

$98

$50

$2

$2

3, Low-demand consumers buy 10 units

2, High-demand consumers buy 14 units

14

16

10

12

Quantity

Quantity

slide23
See example in next page

1, Suppose that the firm can bundle the two goods instead of tie them

2, Produce a bundled product of camera plus 12-shot cartridge

tie in sales24

5, So produce a second bundle of camera plus 16-shot cartridge

7, Profit is $72 from each low-demand consumer and $80 from each high-demand consumer giving $150 per pair of high-demand and low-demand

Tie-In Sales

Low-Demand

Consumers

Demand: P = 16 - Q

$

$

4, High-demand consumers get $48 consumer surplus from buying it

$16

Demand: P = 12 - Q

$12

3, Low-demand consumers can be sold this bundled product for $72

$48

$72

$72

$8

6, High-demand consumers will pay $80 for this bundled camera ($128 - $48)

12

16

12

Quantity

Quantity

complementary goods
Complementary Goods
  • Complementary goods are goods that are consumed together
    • nuts and bolts
    • PC monitors and computer processors
  • How should these goods be produced?
  • How should they be priced?
  • Take the example of nuts and bolts
    • these are perfect complements: need one of each!
  • Assume that demand for nut/bolt pairs is:

Q = A - (PB + PN)

complementary goods cont
Complementary goods (cont.)

This demand curve can be written individually for nuts and bolts

For bolts: QB = A - (PB + PN)

For nuts: QN = A - (PB + PN)

These give the inverse demands: PB = (A - PN) - QB

PN = (A - PB) - QN

These allow us to calculate profit maximizing prices

Assume that nuts and bolts are produced by independent firms

Each sets MR = MC to maximize profits

MRB = (A - PN) - 2QB

Assume MCB = MCN = 0

MRN = (A - PB) - 2QN

complementary goods cont27
Complementary goods (cont.)

Therefore QB = (A - PN)/2

and PB = (A - PN) - QB = (A - PN)/2

by a symmetric argument PN = (A - PB)/2

The price set by each firm is affected by the price set by the other firm

In equilibrium the price set by the two firms must be consistent

complementary goods cont28
Complementary goods (cont.)

2, Pricing rule for the Nut Producer:

PN = (A - PB)/2

PB = (A - PN)/2

PN = (A - PB)/2

PB

 PN = A/2 - (A - PN)/4

A

= A/4 + PN/4

1, Pricing rule for the Bolt Producer:

PB = (A - PN)/2

 3PN/4 = A/4

 PN = A/3

 PB = A/3

A/2

 PB + PN = 2A/3

A/3

 Q = A - (PB+PN) = A/3

3, Equilibrium is

where these two

pricing rules

intersect

Profit of the Bolt Producer = PBQB = A2/9

A/3

A/2

A

PN

Profit of the Nut Producer = PNQN = A2/9

complementary goods cont29
Complementary goods (cont.)

What happens if the two goods are produced by the same firm?

The firm will set a price PNB for a nut/bolt pair.

Demand is now QNB = A - PNB so that PNB = A - QNB

$

 MRNB = A - 2QNB

MR = MC = 0

A

 QNB = A /2

 PNB = A /2

A/2

Profit of the nut/bolt producer is PNBQNB = A2/4

Demand

MR

A/2

A

Quantity

slide30

Merger of the two firms results in consumers being charged

lower prices and the firm making greater profits.

Why? Because the merged firm is able to coordinate the prices of the two goods

complementary goods31
Complementary goods
  • Don’t necessarily need a merger to get these benefits
    • product network
      • ATM networks
      • airline booking systems
    • one of the markets is competitive
      • price equals marginal cost in this market
      • leads to the “merger” outcome
  • There may also be a countervailing force
    • network externalities
      • value of a good to consumers increases when more consumers use the good
network externalities
Network externalities
  • Product complementarities can generate network effects
    • Windows and software applications
      • substantial economies of scale
      • strong network effects
    • leads to an applications barrier to entry
      • new operating system will sell only if applications are written for it
      • but…
  • So product complementarities can lead to monopoly power being extended
anti trust and bundling
Anti-trust and bundling
  • The Microsoft case is central
    • accusation that used power in operating system (OS) to gain control of browser market by bundling browser into the OS
    • need\ to show
      • monopoly power in OS
      • OS and browser are separate products that do not need to be bundled
      • abuse of power to maintain or extend monopoly position
    • Microsoft argued that technology required integration
    • further argued that it was not “acting badly”
      • consumers would benefit from lower price because of the complementarity between OS and browser
microsoft and netscape
Microsoft and Netscape
  • Complementarity products
    • so merge?
    • what if Netscape refuses?
    • then Microsoft can develop its own browser
    • MC ≈ 0 so competition in the browser market drives price close to zero
    • but then get the outcome of merger firm through competition
  • So Microsoft is not “acting badly”
  • But
    • JAVA allows applications to be run on Internet browsers
    • Netscape then constitutes a threat
    • need to reduce their market share
antitrust and tying arrangements
Antitrust and tying arrangements
  • Tying arrangements have been the subject of extensive litigation
  • Current policy
    • tie-in violates antitrust laws if
      • there exists distinct products: tying product and tied one
      • firm tying the products has sufficient monopoly power in the tying market to force purchase of the tied good
      • tying arrangement forecloses or has the potential to foreclose a substantial volume of trade