L17 - Price Discrimination

Question 1

What are some examples of price discrimination?

Answer 1

• train/cinema tickets
• music streaming companies - spotify for students
• food companies - buy one get one free, size of drink you get get at a coffee shop (price doesnt increase linearily)
• UBER - discriminates at certain peak times
• pharmaceutical products

Question 2

What is Price Discrimination

Answer 2

• Price discrimination occurs when different consumers pay a different average price without this being justified by cost differences
• Firms sometimes use nonuniform pricing, where prices vary across customers, to earn a higher profit.
• • Examples
  
  • domestic /international tuitions at universities in,
  • passenger airline tickets
  • senior citizen, student discounts
  • Pharmaceutical products

Question 3

Why do firms engage in price discrimination?

Answer 3

A firm engages in price discrimination by charging consumers different prices for the same based on

• individual characteristics
• belonging to an indentifiable sub-group of consumers
• the quantity purchased

Question 4

Why do firms generate higher profit from partaking in price discrimination?

Answer 4

1. Price-discriminating firms charge higher prices to customers who are willing to pay more than the uniform price
2. Price-discriminating firms sell to some people who are not willing to pay as much as the uniform price.

captures consumer at each level of willingness to pay, so earn more money from those willing to pay more and generate sales and thus profit from those who would have found uniform prices too expensive

Question 5

What are the conditions necessary for Price Discrimination?

Answer 5

Necessary conditions for successful price discrimination:

1. .A firm must have market power (otherwise it cannot charge a price above the competitive price).• Examples: monopolist, oligopolist, monopolistically competitive, cartel
2. A firm must be able to identify which consumers are willing to pay relatively more and there must be variation in consumers’ reservation price, the maximum amount someone is willing to pay
3. .A firm must be able to prevent or limit resale from customers who are charged a relatively low price to those who are charged a relatively high price. –> stops arbitrage –> e.g.

Question 6

When is Resale difficult?

Answer 6

A firm’s inability to prevent resale (arbitrage) is often the biggest obstacle to successful price discrimination.

• Resale is difficult or impossible for services and when transcation costs are high.
• Examples: haircuts, plumbing services, admission that requires showing an ID

Question 7

Are all cases of differential pricing an example of price discrimination?

Answer 7

Not all differential pricing is price discrimination.

It is not price discrimination if the different prices simply reflect differences in costs Examples:

• selling magazines at a newsstand for a higher price than via direct mailing
• consumers at different distances from a plant pay different prices, but the price difference just equals the difference in cost

Question 8

What happens to Total Surplus under Uniform Pricing?

Answer 8

Question 9

What are the different types of Price Discrimination?

Answer 9

• Based on the information that the company has about its consumers

Question 10

What is First-Degree Price Discrimination?

Answer 10

Also known as perfect price discrimination

• • Each unit sold for each customer’s reservation price
  
  • the firm charges each consumer a price that is exactly equal to the maximum he/she is willing to pay
  • Thus each consumer gets zero consumer surplus
  • Firms profit is increased by the amount of consumer surplus that would excist in a competitive marke; all Consumer Surplus is transferred to the firm
• example: collect information through cookies which is being sold to to third parties to tailor prices and ads direction at you
• this has been combatted in the EU with regulations to protect personal data online

Question 11

How do you calculate a companies revenue under Perfect Price Discrimination?

Answer 11

• Produce at Demand = MC as due to perfect price discrimination MR is equal to Demand at every level of quantity produced

Question 12

What does Perfect Price Discrimination look like on a graph?

Answer 12

Question 13

What is the summary of Prefect Price Discrimination?

Answer 13

The perfect price discrimination results of producing where demand equals MC means that the competitive quantity of output gets produced

This outcome is efficient:

• its maximises total welfare
• no deadweight loss is generated

But the outcome is harmful to consumers because all surplus is producer surplus!

Question 14

What is third-degree price discrimination?

Answer 14

Also known as group price discrimination

• Firm charges different groups of customers different prices, but charges any one customer the same price for all units

• Firms divide potential customers into two or more groups (based on some easily observable characteristic, demand elasticity matters) and set a different price for each group.
• e.g. senior or student discounts

Question 15

How do you calculate a companies revenue under Group price Discrimination?

Answer 15

Question 16

Under Group Price Discrimination, how can MR be related to elasticity?

Answer 16

• A change in elasticity in Market B with affect the ratio of the two prices
• Thus the higher price will be charge in the less elastic market segment
  
  • and the more elastic would be willing to changeto a substitute if there was even a slight increase in prices

Question 17

What does Group Price Discrimination look like on a graph?

Answer 17

• UK is less elastic in this case

Question 18

What happens under Group Price Discrimination if arbitrage between the markets can take place?

Answer 18

Country 1 –> p₁ = 6- 0.5Q₁

Country 2 –> p₂ = 9-Q₂

if the two coutnries are interlinked, arbitrage will take place, thus a monopolist will have to charge a single price:

• IF the price is between 6-9 (based on the highest willingness to pay in both countries is no units are sold) then only country 2 will be supplied then the total demand is - p₂ = 9-Q₂
• If the price is below 6, both countries will have a postive demand then the total dierect (direct demand)
• q₁ +q₂ = (12-p) + (9-p) = 21 - 3p
• p = 7- 1/3q

and then

• max π = [(1-q*1/3)-1) x q –> (formula is (p-AC)xQ)
• q* = 9 and p* =4

Question 19

How does Welfare under Group Price Discrimination compare to that under Perfect Price Discrimination?

Answer 19

• Welfare under multimarket price discrimination is lower than it is under either competition or perfect price discrimination.
  
  • Under competition, more output is produced and CS is greater
• The welfare effects relative to uniform price monopoly are indeterminate.
  
  • Both types of monopolies set price above marginal cost, so output is lower than in competition.
• However, under price discrimination it could be improving, giving access to the good to consumers who otherwise would not.

Question 20

What is Second-Degree Price Discrimination?

Answer 20

Also known as nonlinear discrimination

• Firm charges a different price for large quantities than for small quantities

• Price varies only with the quantity purchased, but each customer faces the same nonlinear pricing schedule. e.g. discounts, energy tariffs, sim plans
• Not all quantity discounts are price discrimination; some reflect reductions in firm costs associated with large-quantity sales.
• • Many utilities use block-pricing schedules, by which they charge one price for the first few units of usage (block) and then a different price for subsequent blocks.
  
  • Example: increasing-block pricing associated with electricity; per KWH charge increases the more you use

Question 21

What is an example of declining-block prices?

Answer 21

Consider a firm that uses declining-block prices to maximize profit.

• $70 is charged for 1 ≤ Q ≤ 20
• $50 is charged for Q > 20
• Thus, a consumer who buys 30 units pays $70 x 20 = $1400 for the first block and $50 x 10 = $500 for the second block, for a total of $1900. •
• By contrast, under a non-discriminating monopoly, this consumer would be charged a uniform price of $60 and pay a total of $1,800 for 30 units

Reduces Deadweight Loss that occurs under a single-price monopoly

Question 22

What is Two-Part Pricing?

Answer 22

• Another form of nonlinear pricing, a two-part tariff, is when the firm charges a consumer a lump-sum fee for the right to purchase (first tariff) and a per unit fee for each unit actually purchased (second tariff).
  
  • Think of the first tariff as an “access fee” and the second as a “usage fee”. •
  • Examples:
    
    • A country club charges a membership fee and greens fees to play a round of golf •
    • The state fair charges an entrance fee and a per ticket fee for rides •
    • Cell phone service providers charge a monthly service fee and a fee per text message

Question 23

What does a two-part tariff look like on a graph?

Answer 23

Question 24

What are Tie-In Sales (Bundling)?

Answer 24

• Another type of nonuniform pricing is a tie-in sale, in which customers can buy one product only if they agree to purchase another product as well.
• Requirement tie-in sale: customers who buy one product from a firm are required to make all purchases of related products from that firm •
  
  • Example: photocopying machine buyers must buy services and supplies from same company
• Bundling: two goods are combined so that customers cannot buy either good separately
  
  • Example: Refrigerators are sold with shelve

Question 25

Why do Monopolies decide to advertise?

Answer 25

• Monopoly firms don’t just decide on price and quantity, they also make important decisions about how much to advertise their products.
• (Informative) Advertising may positively influence consumers’ preferences and thereby increase demand for the product. - (however if it abused it can have a negative impact)
• By advertising the monopolist will increase market demand for its good, and then the profit will be higher.
• Thus, if the cost of advertising is less than the benefits from advertising, B, the monopoly’s net profit (gross profit minus the cost of advertising) rises.