9.4 Price Discrimination Flashcards
What is price discrimination?
Price discrimination occurs when different prices are charged to consumers for an identical good or service with no difference in costs.
What are the conditions for firms to conduct price discrimination?
For firms to price discriminate, they must have some element of monopoly power, be able to differentiate between groups and segment the market, and prevent market seepage.
Why do firms in competitive industries not conduct price discrimination?
Firms in competitive industries will be unable to conduct price discrimination, as it is a feature of highly concentrated markets such as oligopoly and monopoly.
How do firms differentiate between market segments?
Firms differentiate between market segments by being able to tell apart segments where there are differing elasticities of demand, charging a high price to consumers where demand is price inelastic and a lower price to consumers where demand is price elastic. Segmentation could be in the form of age, location, and time.
What is market seepage?
Market seepage is when a good is bought in the cheaper market and sold on in the more expensive market but at a slightly lower price than the market price.
How can firms prevent market seepage?
Firms can prevent market seepage with the use of student IDs or selling with proof of purchase.
First Degree Price Discrimination
First-degree price discrimination occurs when each consumer is charged the exact price that they are willing to pay for a good or service. In the market, all consumer surplus that would have existed at a price of P1 is now converted into monopoly profit, maximizing profits considerably for the firm. The use of cookies and data storage allows for firms to have access to this information much more easily than in the past, making this form of price discrimination more likely than in the past.
What is second degree price discrimination?
Second degree price discrimination is also known as excess capacity pricing, where empty seats, space, or excess stocks are sold at a lower price to contribute towards fixed costs.
How does excess capacity pricing work for hotel rooms?
A hotel can fill an extra room at the same marginal cost until they reach capacity, Qcap. A profit-maximizing hotel firm will produce where MC=MR, pricing at P1 with quantity Q1. The problem with remaining at this production point is that excess rooms will be unfilled, the distance from Q1 to Qcap. To contribute towards its fixed costs, the hotel can sell these excess rooms at a price greater than marginal cost at P2, citing last-minute deals becoming available. This way, the hotel is contributing towards its fixed costs or adding to its profits, and consumers benefit from extra consumer surplus of ABC due to purchasing these hotel rooms via a last-minute deal.
Third Degree Price Discrimination
Third-degree price discrimination occurs when a firm is able to segment the market into two different groups, a group with price elastic demand and a group with price inelastic demand. The groups will have varying elasticities of demand due to differences in age, location, and time, for example. In the market for train travel, there are clearly two different market segments; one group where demand is price inelastic, the commuters who travel during peak times, and another group where demand is price elastic, those who travel leisure during off-peak times. A profit-maximizing price-discriminating monopolist could now profit maximize in both markets where MC=MR pricing higher in the peak market and lower in the off-peak market allowing for much greater profit to be made. If a blanket price of Pris charged in both markets, there would be no demand in the off-peak market reducing profits.
What is the allocative inefficiency associated with price discrimination?
Price discrimination produces outcomes that are allocatively inefficient because consumers are exploited by prices being charged greater than marginal cost. Resources are not allocated according to consumer demand, and consumers may get a lower quantity than they desire. Consumer choice is restricted, and prices are high, reducing consumer surplus in the market.
In what forms of price discrimination does the greatest exploitation take place?
The greatest exploitation takes place in first-degree and the price inelastic demand segment in third-degree price discrimination.
How might third-degree price discrimination harm consumers in the long term?
Firms who use third-degree price discrimination may use the excessive profits being made from the inelastic demand market segment to price below costs in the elastic demand market segment in order to drive out competition. This would be against the long-term interest of consumers in the off-peak market who lose out with higher prices charged over time if competition is lacking.
How might third-degree price discrimination worsen income inequality?
Third-degree price discrimination could significantly worsen income inequality because the consumers who are in the price inelastic demand market segment must pay much higher prices, taking a large proportion of their disposable income just in traveling to and from work. If these individuals are the poorest in society, income disparities will increase, especially if the wealthier older generation feature more in the off-peak market.
How can price discrimination promote dynamic efficiency?
Price discrimination can promote dynamic efficiency as the monopolist is making more supernormal profit, which can then be reinvested back into the company in the form of technology advances and R&D. This is hugely beneficial for consumers who will receive brand new, better quality products over time - perhaps able to purchase products that do not yet exist. Prices could be lower over time if technology advances reduce costs for businesses, which are then passed on to consumers. The choice available to consumers would increase too. For the monopolist, new product development can maintain monopoly power, especially if innovations are patentable, and better technology can allow costs of production to be reduced, increasing the profit-making potential of the firm even more over time.
