Chapter 6: Price Discrimination

Question 1

What is the motivation for price discrimination?

Answer 1

To increase profits and capture lost surplus

Question 2

Name the obstacles to price discrimination

Answer 2

1. Consumer identification

2. Arbitrage (due to the law of one price)

Question 3

Why does price discrimination still work in practice?

Answer 3

Frictions in the market i.e transaction costs

Question 4

What is the most basic definition of price discrimination?

Answer 4

Different prices for the same good

Question 5

Define first degree price discrimination

Answer 5

Ability to charge prices equivalent to WTP for each consumer

Question 6

What is the outcome of first degree price discrimination?

Answer 6

All surplus is channelled to the seller

Question 7

Define second degree price discrimination

Answer 7

Discriminating through consumer self-selection

Question 8

Define third degree price discrimination

Answer 8

Discriminating through consumer indicators i.e for students, student id.

Question 9

What are some main characteristics of third degree price discrimination?

Answer 9

1. Easily observable characteristics i.e age, gender etc.
2. No resale possible
3. One price for each consumer group

Question 10

What is the relationship between price charged and elasticity?

Answer 10

Going back to P(1+(1/e))=MC, the group with a lower elasticity is charged more.

Question 11

What is the main limit of market segmentation?

Answer 11

Sellers can’t infinitely segment the market or arbitrage will start coming into play.

Question 12

Describe how sellers practice 2nd degree price discrimination

Answer 12

Through allowing consumers to self select through a choice of:

1. fixed fees + variable costs
2. quantities
3. product quality

Question 13

What are some examples of 2nd degree price discrimination through consumer self selection?

Answer 13

Bundling (tie in sales), versioning, pricing plans

Question 14

How do sellers ensure that high valuation consumers buy a durable good at the high valuation price?

Answer 14

Sellers have to commit to not lowering prices in the future for a high value good. In some cases i.e Xerox, the product is not sold, but leased.

Question 15

Define non linear pricing

Answer 15

When prices do not proportionally reflect increases in quantity consumed. In this case, sellers can again prompt consumers to self-select based on quantities purchased.

Moreover, by charging a lower price to match the lowered valuation of an additional unit of the good, sellers are engaging in first degree price discrimination.

Question 16

Coupons are an example of…

Answer 16

Second degree price discrimination by self selection

Question 17

Explain the equation CS2(p2)-f2>=CS2(p1)-f1 in a multiple tariff system

Answer 17

The differential between WTP under p2 and fixed fee 2 must be bigger than that between WTP under p1 and fixed fee 1 for the high value consumer (applies to the two part tariff system scenario)

Question 18

Explain the incentive constraint WTP2 - P2>= WTP1-P1

Answer 18

For consumers to pay P2, the differential between WTP2 and P2 must be larger than WTP1-P1. This is based on the assumption that high value consumers can immediately become low value consumers if the surplus extracted is high enough.

Question 19

How can the constraint WTP(h)-Ph>=WTP(l)-Pl be solved?

Answer 19

Find Pl, which is the valuation of the low value good,

since…
low valuation consumers will never switch to the high valuation good

meaning…
the firm should charge low valuation consumers a price= the valuation of the low value good.

Once Pl is found, substitute back into original constraint and then solve for Ph, assuming WTP(h) and WTP(l) are known.