10.3 Price Discrimination Flashcards
What is price discrimination?
The sale by one firm of different units of a product at two or more different prices for reasons not associated with differences in cost.
Price discrimination occurs when a producer charges different prices for different units of the same product for reasons not associated with differences in cost.
What is the difference between discriminatory and non-discriminatory price differences?
If price differences reflect cost differences, they are not discriminatory. When price differences are based on different buyers’ valuations of the same product, they are discriminatory.
When Is Price Discrimination Possible?
- The Firm must have Market Power.
- If the firm is able to determine the willingness of its various consumers to pay. Consider two situations. First, any given consumer might be prepared to pay a different price for different units of the good. Second, some consumers might be prepared to pay more for the same good than other consumers are. In this second situation, if the firm is able to determine which consumers are prepared to pay a high price and which are prepared to pay only a low price, the firm is able to segment the market.
- Must be able to prevent arbitrage
What is arbitrage?
Whenever the same product is being sold at different prices, there is an incentive for buyers to purchase the product at the lower price and re-sell it at the higher price, thereby making a profit on the transaction. This is called arbitrage.
What are the two different kinds of price discrimination?
Price discrimination among units of output and Price discrimination among market segments.
What is a firm that charges difference prices for different units of output trying to capture?
A firm that charges different prices for different units of a product is trying to capture some of this consumer surplus.
Why is price discrimination among market segments more comon than price discrimination among units.
It is usually much easier for firms to distinguish between different groups of consumers of a product—different market segments—than it is to detect an individual consumer’s willingness to pay for different units of that product. As a result, price discrimination among market segments is more common than price discrimination among units.
What are some examples of different segments that price discrimination may be applied to?
Suppose a firm with market power faces a market demand curve that is made up of distinct market segments. These segments may correspond to the age of consumers, such as children, adults, and seniors. Or the segments may correspond to different regions in which the consumers live, such as the North American automobile market being segmented into the Canadian and U.S. segments.
Suppose the firm recognizes the distinct market segments and is able to prevent any purchase-and-resale between them. What is the firm’s profit-maximizing pricing policy?
The answer is for the firm to charge a higher price in the market segment with the less elastic demand
What does the market segment with less elastic demand represent to a firm?
The market segment with less elastic demand therefore contains consumers that are more “committed” to this product than are the consumers in the market segment with more elastic demand. To put it differently, the consumers with less elastic demand represent a more “captive” market for the firm.
How will the profit maximizing firm change this price in regards to elasticity/”captivity”?
It should not be surprising, therefore, that the profit-maximizing firm will charge a higher price to the more captive consumers and a lower price to those consumers who can more easily substitute away to other products.
Profit-maximizing price discrimination results in higher prices in those market segments with less elastic demand.
Why is price discrimination easier for services as opposed to goods?
Price discrimination is easier for services than for tangible goods because for most services the firms transact directly with the final customer and thus can more easily prevent arbitrage.
What is a way of preventing arbitrage on widely used products?
Grocery stores and drugstores often have promotions with widely used products (toilet paper and paper towels, for example) on sale at heavily discounted prices. What prevents entrepreneurial shoppers in these situations from buying a large number of units at the special price and re-selling them to others at a higher price? The answer is that firms usually place quantity limits on special deals, thus preventing any large-scale arbitrage that would undermine their pricing policy.
What is hurdle pricing?
Hurdle pricing exists when firms create an obstacle that consumers must overcome in order to get a lower price. Consumers then assign themselves to the various market segments—those who don’t want to jump the hurdle and are willing to pay the high price, and those who choose to jump the hurdle in order to benefit from the low price.
Our first proposition is about the consequences of price discrimination for firm profits:
For any given level of output, price discrimination by the firm will provide higher profits than the profit-maximizing single price.
