Chapter 6: Price Discrimination Flashcards
What is the motivation for price discrimination?
To increase profits and capture lost surplus
Name the obstacles to price discrimination
- Consumer identification
2. Arbitrage (due to the law of one price)
Why does price discrimination still work in practice?
Frictions in the market i.e transaction costs
What is the most basic definition of price discrimination?
Different prices for the same good
Define first degree price discrimination
Ability to charge prices equivalent to WTP for each consumer
What is the outcome of first degree price discrimination?
All surplus is channelled to the seller
Define second degree price discrimination
Discriminating through consumer self-selection
Define third degree price discrimination
Discriminating through consumer indicators i.e for students, student id.
What are some main characteristics of third degree price discrimination?
- Easily observable characteristics i.e age, gender etc.
- No resale possible
- One price for each consumer group
What is the relationship between price charged and elasticity?
Going back to P(1+(1/e))=MC, the group with a lower elasticity is charged more.
What is the main limit of market segmentation?
Sellers can’t infinitely segment the market or arbitrage will start coming into play.
Describe how sellers practice 2nd degree price discrimination
Through allowing consumers to self select through a choice of:
- fixed fees + variable costs
- quantities
- product quality
What are some examples of 2nd degree price discrimination through consumer self selection?
Bundling (tie in sales), versioning, pricing plans
How do sellers ensure that high valuation consumers buy a durable good at the high valuation price?
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.
Define non linear pricing
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.
Coupons are an example of…
Second degree price discrimination by self selection
Explain the equation CS2(p2)-f2>=CS2(p1)-f1 in a multiple tariff system
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)
Explain the incentive constraint WTP2 - P2>= WTP1-P1
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.
How can the constraint WTP(h)-Ph>=WTP(l)-Pl be solved?
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.
