A PARABLE ABOUT PRICING
To understand why a monopolist would want to price discriminate, let’s consider a simple example. Imagine that you are the president of Readout Publishing Company. Readout’s best-selling author has just written her latest novel. To keep things simple, let’s imagine that you pay the author a flat $2 million for the exclusive rights to publish the book. Let’s also assume that the cost of printing the book is zero. Readout’s profit, therefore, is the revenue it gets from selling the book minus the $2 million it has paid to the author. Given these assumptions, how would you, as Readalot’s president, decide what price to charge for the book?
Your first step in setting the price is to estimate what the demand for the book is likely to be: Readalot’s marketing department tells you that- the book will attract two types of readers. The book will appeal to the author’s 100,000 die-hard fans. These fans will pay as much as $30 for the book. In addition, the book will appeal to about 400,000 less enthusiastic readers who will pay up to $5 for .the book.
What price maximizes Readalot’s profit? There are two natural prices to consider: $30 is the highest price Readalot can charge and still get the 100,000 die-hard fans, and $5 is the highest price it can charge and still get the entire market of 500,000 potential readers. It is a matter of simple arithmetic to solve Readalot’s problem. At a price of $30, Readalot sells 100,000 copies, has revenue of $3 million, and makes profit of $1 million. At a price of $5, it sells 5~0,000 copies, has revenue of $2:5 million, and makes ‘profit of $500,000. Thus; Readalot maximizes profit by charging $30 and forgoing the opportunity to sell to the 400,000 less enthusiastic.