L16 - Price Discrimination Flashcards
What are the condition necessary for Profitable Price Discrimination?
C(1) –> SELLERS MUST BE PRICE MAKERS
- If the seller is a price taker, the market determines the price
- Buyers have little choice if the seller has some market power over the buyer
C(2) –> BUYERS MUST DIFFER & SELLERS MUST BE ABLE TO IDENTIFY BUYERS
- If buyers are identical, then no need to price discriminate!
- It may not be possible for a seller to distinguish between Miss Rich and Mr Poor
- Partial identification maybe possible (i.e. students, OAPs, prior purchases)
C(3) –> CONSUMERS MUST NOT BE ABLE TO PARTICIPATE IN ARBITRAGE
- Arbitrage: when buyers, who are charged a low price, purchase the good
then sell it to a buyer who otherwise would have paid a high price
What Assumption do we make when using Price Discrimination?
We retain A(1) from lecture 1, and adapt A(2):
- buyers are price takers and buyers have complete information
- (seller’s information about buyers will vary across examples)
A(3) –> THE SELLER IS A PURE MONOPOLIST
- Price discrimination can occur in markets with more than one seller
- Focusing on monopoly allows understand the problem without unnecessary
complications
A(4) –>ENTRY IS BLOCKED
- A potential seller cannot enter the market. Not even in the long-run
- The analysis does not change between the short- and the long-run
What is First-Degree Price Discrimination?
- Also known as Perfect Price Discrimination
- First-degree price discrimination is where:
- Sellers charge each buyer the maximum price the buyer is willing to pay
- This clearly entails charging different prices to different buyers
- It may also entail charging the same buyer different prices for each unit
For example:
suppose Miss Rich wanted to buy two units
she was willing to pay £40 for the first and £20 for the second
then she would be charged £40 for the first and £20 for the second
While first-degree price discrimination is unlikely in the real world, it is an
important extreme case that we can build upon
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How much is produced under first-degree price discrimination?
- As always, profits maximised by the marginal output rule: MR = MC
- The ability to price discriminate changes MR curve
REMINDER: single price monopolist
To sell another unit the price has to fall. This has two effects total revenue:
1. another unit is sold at the lower price, so TR increases
2. all other units are sold at a slightly lower price, so TR decreases
-So, MR is lower than AR
What is the effect of first-degree price discrimination on a price discriminating monopolist?
- The price charged for all other units does not change under price discrimination
So, MR is equal to AR (since TR increases by the price charge for the unit p = AR)
What does First- Degree Price Discrimination and Welfare look like on a Graph?
- like perfect competition graph
- Price on the y-axis and Quantity on the x-axis
- negative gradient line of Demand= AR =MR
- equilibrium is at the point Q{fd} where MC=MR
- the triangle shaped area to the left of the equilibrium point is the Producer Surplus
- there is No dead weight loss, but consumer surplus is zero ( as all consumers are getting the price they are willing to pay)
How can the graph on First Degree Price Discrimination and Welfare be interpreted?
A monopolist that practices first-degree price discrimination:
(a) produces the same output as a perfectly competitive seller
(b) produces more than what it would if it couldn’t price discriminate
Total welfare is the same as under perfect competition!
Why is Total welfare the same under perfect competition under First Degree price Discrimination?
All buyers whose willingness to pay is above marginal cost purchase the good
So, there is no deadweight loss
The difference:
- monopolist charges different prices for each unit sold –> the maximum willingness to pay
- The monopolist extracts all of the gains from trade: no consumer surplus
- a perfectly competitive seller price is equal to marginal cost for all units sold
What is Third-Degree Price Discrimination?
Third-degree price discrimination is where:
- a seller can identify different groups of buyers and the prices charged
to these groups differ
A) Buyers can be grouped in terms of their characteristics
EXAMPLE: students may have lower willingness to pay than non-students
(the same is true for old age pensioners)
B) Buyers can also be grouped in terms of the country they live in
EXAMPLE: Buyers in a developed country have a higher willingness to pay
- The analysis is very similar to the analysis of a non-discriminating monopolist
- Subtle difference when marginal costs are increasing in output
What does Third-Degree Price Discrimination look like on a graph?
- Say is you had Market X and Market Y both, with a negative line of Demand and MR to the left of it, expect Market X is more inelastic with a steep gradient and Market Y is more elastic with less of a decline
- To create the total Markets graph of X and , imagine you overlaid both graphs over each other, then the total markets line for Demand and MR will be which of the two lines is above the other market e.g. the start of the two Curve with be steep like Market X but then flatten out and follow Market Y
- This is Horizontally summing MR{X} and MR{Y} to give the total MR curve
- This graph will also have a positive MC curve on it
- To figure out the price that will be charged in each individual market would be you would draw the graphs side by side and where MR=MC on the total market graph you draw a line across both the graphs to find the quantity produced at the point where it cross their respective MR lines and the Price sold at the point directly above on the Demand lines
What would happen in Third Degree Price Discrimination if the Market wasnt allowed to be Discriminated?
The price of a single-price monopolist:
- lies in between the prices charged to these two groups
- Prohibiting price discrimination will benefit some buyers (inelastic) but not others (elastic)
Third-degree price discrimination
- On the graph we would have to Horizontally Sum the demand curves onto the total markets graph X and Y
- At the point D=MC we draw a line across onto the other single market graphs at the point they cut their respective demand curves is the price that will be charged in all markets ( between the two prices of those markets)
How can the Graph of Third-Degree Price Discrimination be interpreted?
A monopolist that practices third-degree price discrimination
a) produces the same output as it would if it did not price discriminate
The main difference:
● Price is lower for buyers with elastic demand
● Consumer surplus is positive
● There is an associated dead weight loss: prices are above marginal cost
What is Second-Degree Price Discrimination?
Second-degree price discrimination is where:
- a seller can use a menu of “non-linear tariffs” in order to get buyers to reveal their
preferences when they select their preferred tariff
- Tariffs are linear when the same price is charged for every unit sold
- Tariffs are non-linear when the (average) price per unit changes
FOR EXAMPLE: Suppose our monopolist is a mobile phone operator
- Linear tariff: 25p per minute for phone calls
- Non-linear tariff: £10 per month and 5p per minute
Which Users would Prefer the different tariffs of Second-Degree Price Discrimination?
- Low-users will prefer
the linear tariff - High-users will prefer
the non-linear tariff
