3.4.5 Flashcards
What is price discrimination?
A firm price discriminates when it charges different prices to different consumers for reasons that do not reflect cost differences
What are necessary conditions for price discrimination? (4)
- The firm must have price-setting powers
- At least two consumer groups with different price elasticities of demand
- The firm should be able to identify consumers in each group and set different prices for each
- The firm must be able to prevent consumers in one group from selling to consumers on another
What does a consumer group with INelastic PED look like? (price discrimination)
- What does this mean? (Consumer PED)
- Costs are equal so there is a perfectly elastic MC/AC curve
- MR/AR - more inelastic
- The consumers in this group are charged a higher price as their PED < 1
- Profit drawn up from Q1 (where MR = Magna Carta)
What does a consumer group with ELASTIC PED look like? (price discrimination)
- What does this mean? (Consumer PED)
- Costs are equal so there is a perfectly elastic MC/AC curve
- MR/AR - more elastic so Q is greater
- Consumers in this group are charged a lower price as their PED > 1
- Profit drawn up from Q1 (where MR = MC)
What does the whole market diagram look like in price discrimination?
- What does this mean for the firm?
- Straight lines then after the MC=AC curve kinked towards right
- Q is in-between both prior inelastic and elastic curves
- If the firm chooses to split up the market and price discriminate then the combined areas of all profit will be greater than charging a single price for all groups
What are advantages of price discrimination to the PRODUCER? (7)
- Higher total output than just MC=MR
- Profits may finance innovation and R&D = dynamic efficiency
- Price discrimination may increase total sales and generate economies of scale
- Can act as a barrier to entry reducing competition
- Benefits firms through higher profits as a price discriminating business can extract consumer surplus and turn it into supernormal profit
- Profits made in one market may allow the firm to cross-subsidies loss making in other areas for example a transport company and night/rural services
- Aggressive price discrimination may allow a firm to survive in a recession
What is consumer surplus?
- Consumer surplus is the difference between the total amount that they would be willing and able to pay for a g/s (shown by the demand curve) and the total amount they do pay
- At all points on the demand curve before the equilibrium consumers are willing to pay more for the g/s than they actually have to
What is the impact of price discrimination on CONSUMER surplus?
- Below demand curve and above price
- Consumer surplus can be extracted and turned into additional revenue, by charging different market segments different prices
What are disadvantages of price discrimination on the PRODUCER?
- May make a market more contestable as it could be used as a predatory pricing tactic to harm competition and increase a firm’s market power
- Admin costs
What is the importance of marginal cost in price discrimination?
In markets where the MC of an extra passenger is low the firm has an incentive to use price discrimination to sell all tickets
- Once the company is due to depart anyway the Marginal Cost of an extra passenger is very low justifying selling remaining places at a lower price
(Better to make some money than none at all)
What are advantages of price discrimination to the CONSUMER?
- Some consumers are brought into the market through lower prices who may not have been able to afford the g/s otherwise
- Higher output than under a single price monopoly
- Increase profits for monopoly suppliers may be used to finance R&D which could improve consumer welfare in the long run
- Profits made from price discrimination may be used to cross-subsidise other actives that benefit consumers (night/rural transport, rich vs poor clients)
- Economies of scale achieved through greater output may lead to lower prices for consumers
What are disadvantages of price discrimination to the CONSUMER?
- Some consumers will face a higher price than if there was a single price
