Chapter 6 Flashcards
Price discrimination
The practice of setting different prices for the same good, whereby the relevant price in each case depends on the quantity purchased, on the buyer’s characteristics or on the various sale clauses
Why price discriminate?
The goal of price discrimination is to get a slice of untapped revenue source
Price discrimination allows the seller to create additional consumer surplus and to capture existing consumer surplus. Its success requires that resale be expensive or impossible
Customer markets
Markets where sales terms are tailored to each individual customer, because we know each consumer’s valuation and we are able to charge a different price from each customer
Perfect price discrimination
When the seller has perfect information about each buyer’s valuation and is able to set a different price to be paid by each buyer.
Condition to price discriminate
Market frictions: physical impossibility of resale, transaction costs, imperfect information, and legal restrictions
Types of price discrimination
Selection by indicators: seller can exactly determine whether the buyer belongs to a certain market segment and charge accordingly –> observable buyer characteristics
Self-selection: seller has some information about the buyers preferences but cannot observe the characteristics of each particular buyer –> induces buyer to self-select among different product offerings
Degrees of price discrimination
first-degree: perfect price discrimination
second-degree: when the price depends on quantity purchased but not on the identity of the consumer
Third-degree: when different prices are set in different market segments
Market segmentation
When the seller divides buyers into groups, setting a different price for each group
profit maximisation monopolist selling to 2 separate markets (price discrimination)
MR1=MR2=MC
p1(1+ 1/e1) = p2(1+ 1/e2) = MC –> If elasticity is constant
Home bias
A feature of the demand function, where in general demand elasticities tend to be lower in the domestic market.
The limits of market segmentation
The problem with fine segmentation is that either the elasticity in each submarket is very similar to that of neighbouring submarkets (segmentation is not really beneficial)
Or the elasticities vary a lot across neighbouring submarkets (resale or arbitrage problerm)
The internet, big data, and price discrimination
Technological advancement brings seller closer to the perfect price discrimination extreme.
However, if sellers know more about buyers, buyers also now more about sellers, which makes price customisation more difficult (due to the internet for example).
Versioning and damaged goods
Price discrimination by versioning leads to a higher revenue for the seller.
One extreme form of versioning occurs when firms reduce the quality of some existing products in order to price discriminate –> produce damaged goods.
Incentive constraint
Making sure that a high-end consumer has no incentive to go for the deal that is intended for the low-end consumer –> strictly positive surplus
Participation constraint
Version intended for the low-end consumers, so prices cannot be greater than the low-end consumer willingness to pay –> net surplus of zero
Bundling/tie-in sales + 2 types
An alternative strategy for sorting consumers and price discriminate between them
Price bundling = buyers must purchase the bundle or nothing
Mixed bundling = buyers are offered the choice between purchasing the bundle or one of the separate parts
What benefit does the price discrimination of durable goods over and why might a firm decide against it?
Time. It allows sellers to price skim, sell both to high-valuation buyers at a high price and to low-valuation buyers at a low price –> valuation and impatience are normally correlated.
However, when selling a durable good, sellers may prefer to not price discriminate over time. In fact, due to strategic purchase delays, profits may be lower under price discrimination. (slower sales and an average lower price)
Coase conjecture
the waiting game my unravel to the point that the seller has to lower the price form the get-go
Ways to reduce the disadvantages of pricing durable goods
To not commit to lower prices in the future
Seller may decide to not sell, but only lease
Introduce some sort of product differentiation that further separates high-valuation from low-valuation buyers
Seller may require a reputation for not lowering prices
Non-linear pricing
A nonlinear price schedule is a menu of different-sized bundles at different prices, from which the consumer makes his selection
Two-part tariff + A monopolist optimal case
Simplest case of non-linear pricing is a two-part tariff: a fixed part f and a variable part p
A monopolist’s optimal two-part tariff consists of a positive fixed fee and a variable fee that is lower than the monopoly price. Total surplus is therefore greater than under uniform pricing. price = MC, f = CS
Multiple consumer types and multiple two-part tariffs
Given that there are different types of consumers, it is natural to assume that the seller sets different two-part tariffs –> take into account incentive constraint and the participation constraint.
Optimal pricing with different two-part tariffs (different consumers)
f1 = CS(p1) & p1 > c. thus low consumption types pay low fixed fee and high marginal fee
f2 > f1 & p2 = c. thus high consumption types pay a high fixed fee and low marginal fee
Optimal value CS2*(p2) - f2 = CS2(p1) - f1
left-side is the net value a type 2 obtains from choosing plan 2, the right-side is the value that a type 2
obtains from choosing type 1.
Loss of profits is the price the seller must pay to sort buyers by means of self-selection. The loss has two parts:
- deadweight loss due to p1 > c
- leaving some surplus with the high-use consumers f2 < CS2(c)
Types of auctions
Ascending price auction
Descending price auction
First-price auction
Second-price auction
Bidding strategy
Buyer’s strategy is a bidding strategy that amounts to a trade-off similar to that of a monopoly seller. The optimal bid strikes the right balance between your valuation and the bid you pay, just like in monopoly pricing (MR=MC
Winner’s curse
If you win the auction it is because my rival submitted a lower bid. If your rival submitted a low bid, it’s because the value of the object is probably low;
If you win the auction, it is probably because the value is lower than expected.
Multi-object auctions (3)
Discriminatory auction: each bidder declares how much it is willing to pay for a given amount of securities. The highest bids are collected to the point where demand = amount offered for sale. Winners get the amounts they demanded at the price they offered.
Uniform price auction: the same set of bidders get the same number of securities but the price they pay equals the lowest winning bid.
Simultaneously ascending auction: selling multiple objects that are different but related in value. Each round bidders submit bids for each object on the block. Each new bid must be higher than the previous highest bid plus a minimum increment. The overall auction ends when no new bids are submitted for any object.
Relevant points in the comparison between the solutions with and without price discrimination
Total welfare is often greater under (perfect) price discrimination
Consumer welfare is lower under price discrimination
Different consumers pay different prices under price discrimination
Mor e consumers are served under price discrimination
Considerations price discrimination (4)
It may happen that total efficiency decreases as a result of price discrimination
There are cases when price discrimination applies a strict Pareto improvement: both the seller and consumer are made better off
Consumers dislike paying different prices. (prospect theory of consumer behaviour: consumers like paying a lower price than others, but hate paying a higher price than others much more –> fairness issue)
