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
- by selling a product to a consumer for a price PS,
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.
- by renting it out to a consumer for a price PR, 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
Coase, R. (1972). Durable Goods Monopolists. Journal of Law and Economics,
vol. 15, pp. 143-150.