Durable Goods Monopoly

In microeconomic analysis theorists focus on two types of goods. Flow goods are those that are purchased repeatedly and that perish after use, for example food products. In contrast, durable goods are purchased infrequently and can be used repeatedly. Examples include cars, houses, and land.

Coase (1972) first pointed out that a monopolist that sells a durable good will behave differently from the familiar monopoly selling a perishable good. Coase considered the case of railroad that owns all of the land in a town along its right-of-way. The monopolist wants to earn as much profit as possible from the sale of the land, so it limits the amount that it makes available for sale.

Standard monopoly analysis suggests that the monopoly will restrict output and raise price high enough so that not all of the land is sold. Suppose the monopoly charges the monopoly price and sells half of its land by the end of this year. Next year, the monopoly still owns the remainder of the land in the town and it can make an additional profit by selling a portion of the remaining land in the second year. However, in the second year (if population is not growing very fast) the demand for land will be lower than the demand for the land this year. Thus, the monopoly land price will be lower in the second year than the monopoly price this year. Given that the monopoly's price next year will be substantially lower than the monopoly land price this year, those consumers who do not discount time too heavily would postpone buying land until the second year. Hence, the current demand facing the monopoly falls, implying that the durable good monopolist will charge a lower price than what a monopoly selling a perishable good would charge.

Suppose a durable good monopoly faces a downward-sloping demand curve. Suppose there is a continuum of consumers having different valuations for the annual services of a car summarized by the downward-sloping demand curve. Suppose that consumers live for two periods, denoted by t, t = 1,2 and that a monopoly sells a durable product that lasts for two periods. So if a consumer purchases the product she will have it for her entire life. The consumers have different valuations for the product. At period t = 1 this is given by the aggregate demand p = f(Q).

Consider the following two options

1. by selling a product to a consumer for a price P^S, the firm transfers all its rights of ownership for using the product and getting the product back from the consumer from the time of purchase.
2. by renting it out to a consumer for a price P^R, the renter maintains ownership of the product, but contracts with the consumer to allow the consumer to derive services from the product for a given period specified in the renting contract.

It can be shown under reasonable specifications that in the above situation a monopoly selling a durable good earns a lower profit than a monopoly renting. In fact such models led some economists to argue that monopolies have incentives to produce less than an optimal level of durability (e.g., light bulbs that burn very fast).

For a variant of the durable good problem click next.

Reference

Coase, R. (1972). Durable Goods Monopolists. Journal of Law and Economics, vol. 15, pp. 143-150.