Lecture 5 - Price Discrimination Flashcards
What does price discrimination mean?
Price discrimination refers to any non-uniform pricing policy used by a firm with market power to maximize profits
=charging customers different prices for the same product
=charging a customer a price that varies depending on how many units the customer buys (2nd degree price discrimination, similar to a “volume discount”)
Why do firms engage in price discrimination?
To increase its profits by trying to extract unexploited surplus (from the point of view of the firm) under uniform pricing
How can price discrimination increase profits?
Think of a monopolist that charges a uniform price:
Given the inverse demand p(q), the monopolist sell q* such that MC(q)=MR(q)
Recall that MR is the sum of two effects:
1) Increase in revenue from selling one more unit
2) Decrease in revenue on all existing output
=All methods of price discrimination can be viewed as attempts to minimize this second effect on MR from expanding sales
Under which conditions can a firm engage in price discrimination?
1) Market Power: A firm must have some market power (ability to set p>MC)
2) Identifying WTP: The firm must be able to identify whom to charge the higher price
e. g., to know the WTP for each unit (the height of consumer demand)
3) Resale: Ability to prevent or limit resale by customers who pay the lower price to those who pay the higher price
3 Types of price discrimination?
1) Perfect price discrimination (or first-degree price discrimination) = Personalized pricing
2) Second-degree price discrimination = Menu pricing
3) Market segmentation (or third-degree price discrimination) = Group pricing
Which type of buyers’ information can be used to price discriminate?
- Buyer characteristics such as student status/age/gender
- Location
- Buyers’ ability to be flexible about time
- By effort (case of coupons)
- The fact that some consumers are less informed than others
1st degree price discrimination: summary
Consumers are left with no surplus
Producers supply the same amount as in perfect competition
There is no efficiency loss (the price on the last purchase still equals MC)
But it affects the distribution of surplus
Compared to a non-discriminating monopoly, the monopoly here does not decrease revenues on the first units sold when it sells additional units at a lower price => demand becomes the MR curve
How do profits and consumer surplus for each group change when a monopolist optimally decides to 3rd degree price discriminate instead of charging a uniform price?
Profits increase. Because the firm could choose a uniform price, but it does not do so. This indicates that profits are higher in the price discrimination!
Consumers in the market with lower elasticity are worse off, since the price in this market has increased (the CS triangle gets smaller)
Consumers in the market with higher elasticity are better off, since the price in this market has decreased (the CS triangle gets larger)
What are the conditions for price discrimination to be successful?
First, there must be types or groups of consumers that differ from each other in the valuation for the monopolist’s product.
Second, for the firm to be able to price discriminate, it is necessary that the firm has some market power. Otherwise, the firm is a price taker and can therefore not set different prices.
Third, for the firm to able to price discriminate, it must be possible for the firm to distinguish between the different types of consumers or consumer groups. If this was not possible, the firm would not know whom to charge what price.
Fourth, for the firm to able to price discriminate, consumers must not be able to resell the products. Otherwise the group of consumers that faces the low price would have an incentive to buy the product at a low price and sell it to the group that faces a high price at a marginally lower price. The firm would then not be able to sell any products at the high price
Why do profits increase if the monopolist optimally decides to 3rd degree price discriminate?
A (price-discriminating) monopolist always has the option to charge the same price to all consumers. Hence, if a monopolist charges different prices to different consumers, it must be the case that she gets higher profits from charging different prices that from charging the same price to all consumers.
(iii) What is a sufficient condition for welfare to be lower with a discriminating monopolist than with a non-discriminating monopolist?
From the lecture we know that it is a necessary condition for welfare to be higher with a discriminating monopolist than with a non-discriminating monopolist that output is higher with discrimination. This implies that if output is not higher with price discrimination than without price discrimination, welfare cannot be higher with price discrimination than without price discrimination.
