Chapter 16: Price Discrimination

Question 1

Price Discrimination Conditions (3)

Answer 1

1. ) Firm must have market power (downward sloping demand curve)
2. ) Two or more identifiable classes of buyers must be separable at a cost that does not exceed the monetary gain from separating (different demand elasticities)
3. ) Resale by those buyers who pay a low price to those who would be charged a higher price must be deterred

Question 2

3 Degrees of Price Discrimination: 1st Degree

Answer 2

Perfect Price Discrimination (rarely observed)

• Charging a different price for every unit of the product
• For each unit sold, there is a different price, set to a reservation price (the highest price that the buyer is willing to pay for the product)
• Requires information
• Welfare is actually higher

Question 3

3 Degrees of Price Discrimination: 3rd Degree

Answer 3

• Firms are able to separate consumers into two or more groups according to their different elasticities of demand.
• Consumers are put into a group by the firm and cannot self-select into another group
• Ex.) Movie theatres
• P1 > P2
• MR1 = MR2 = MC
• Generally, with linear demand and linear marginal cost curves, price discrimination reduces welfare
• However, it becomes very complicated and ambiguous
• An increase in output is a necessary, but not sufficient condition for welfare to increase

Question 4

Two-Part Tariff

Answer 4

• A two part tariff consists of a lump sum payment for a good or service combined with a per unit user charge
• Ex.) Amusement park - entrance fee and per-attraction charge

Question 5

Tie-In Sales

Answer 5

Under a tie-in sales agreement, consumers can purchase a good only if they agree to purchase another good.

Question 6

Tie-In: Bundling

Answer 6

Bundling is a tying agreement in which goods are purchased in fixed proportions.
Ex.) Internet Explorer browser with Windows operating system
Ex.) Restaurant that serves only fixed-price menu including an appetizer salad, entree, and dessert

Question 7

Tie-In: Requirements Tie-In Sales

Answer 7

• Consist of a tying agreement in which the goods are purchased in variable proportions
• Under a typical requirements tie-in contract, firms require that their customers buy or lease a machine or equipment and then prucahse the inputs used with the machine from the same supplier
  Ex.) McDonald’s requiring all of its franchises to purchase paper cups from McDonalds

Question 8

3 Degrees of Price Discrimination: 2nd Degree

Answer 8

• Seller charging two or more prices, but fewer prices than units sold, and each unit is sold at the highest profitable price among those quoted by the seller
• All consumers are offered the same price schedule, and then consumers self-select into different price categories.
• Sellers are not able to differentiate between different types of consumers. Thus, the suppliers will provide incentives for the consumers to differentiate themselves according to preference, which is done by quantity “discounts”, or non-linear pricing
• Ex.) Black Friday

Question 9

Mixed Bundling

Answer 9

• A strategy observed by managerial economists that increases profits for business is mixed bundling. Mixed bundling allows customers to purchase the goods either together as a bundle or separately.

Question 10

Vertical Restraint

Answer 10

• Competition restrictions in agreements between firms or individuals at different levels of the production and distribution process. Vertical restraints are to be distinguished from “horizontal restraints”, which are found in agreements between horizontal competitors
• Can take numerous forms, ranging from a requirement that dealers accept returns of a manufacturer’s product, to resale price maintenance agreements setting the minimum or maximum price that dealers can charge for the manufacturer’s product.

Question 11

Vertical Restraint: Market Restriction

Answer 11

I will let you distribute my product, but only in the province of Alberta

Question 12

Price Maintenance (Resale price maintenance RPM)

Answer 12

• Practice in which the manufacturers seek to fix the min or max retail price of their products. The manufacturer may impose the retail price on the retailer or it may be a joint agreement between the two on the prices to be charged. RPM can be detrimental to consumers as it prevents them from negotiating discounts on the price of products/services.
• Differences in retail costs of various retailers are not passed to the consumer in the form of different retail prices
• May facilitate collusion at the retail level

Question 13

Vertical restraints are unlawful if (3):

Answer 13

• The tribunal finds that exclusive dealing or tied selling, because it is engaged in by a major supplier of a product in a market or because it is widespread in a market, is likely to:
  1. ) impede entry into or expansion of a firm in a market
  2. ) impede introduction of a product into or expansion of sales of a product in a market
  3. ) have any other exclusionary effect in a market
• If a firm is vertically integrated, it can make all of those decisions on its own and there wouldn’t be any question of the firm being anti-competitive