lesson 8 - pricing with market power

Question 1

What is Price Discrimination?

Answer 1

Charging different prices for the same good/service, not justified by cost differences. Goal: Capture more consumer surplus.

Question 2

Requirements for Price Discrimination

Answer 2

1. Market Power; 2. Segmentable Consumers; 3. Infeasible Resale

Question 3

First-Degree Price Discrimination (FDPD) Definition

Answer 3

Charging each consumer their maximum willingness to pay (WTP). Also called perfect price discrimination.

Question 4

Second-Degree Price Discrimination (SDPD) Definition

Answer 4

Offering a menu of options and letting consumers self-select (quantity discounts, block pricing, two-part tariffs, versioning). Also called indirect price discrimination.

Question 5

Third-Degree Price Discrimination (TDPD) Definition

Answer 5

Segmenting the market into groups and charging different prices to each group.

Question 6

FDPD Outcome

Answer 6

• zero CS
• max PS
• no DWL

Question 7

third degree price discrimination RULE 1

Answer 7

allocate output across segment such that MR₁ = MR₂ = … = MRₙ (Marginal Revenue is equal across all segments).

Question 8

TPTD Rule 2

Answer 8

Total quantity (QT) should be where total marginal revenue (MR) equals marginal cost (MC): MR = MC

Question 9

TDPD Pricing Rule of Thumb (2 segments)

Answer 9

More elastic segment gets the lower price.

Question 10

Two-Part Tariff Optimal Strategy (Homogenous Consumers)

Answer 10

Set per-unit price = MC (Marginal Cost),

Fixed Fee = Consumer Surplus at P=MC

Question 11

Imperfect First-Degree Price Discrimination

Answer 11

Estimating WTP based on observable characteristics (e.g., occupation, address). Similar to TDPD.

Question 12

Examples of TDPD

Answer 12

Student/senior discounts, international textbook editions, different prices for locals vs. tourists.

Question 13

Examples of SDPD

Answer 13

Quantity discounts, block pricing (utilities, phone plans), two-part tariffs (country clubs, gyms), versioning (software, airline tickets), coupons, intertemporal pricing.

Question 14

Continuous vs. Discrete Characteristics in Price Discrimination

Answer 14

Continuous (income, test scores): Imperfect PD. Discrete (student status, location): TDPD.

Question 15

Steps to Solve a TDPD Problem (with given inverse demand functions and MC)

Answer 15

1. Find MR for each segment;
2. Set MR₁ = MR₂ = MC;
3. Solve the system of equations to find Q₁ and Q₂; 4. Use inverse demand functions to find P₁ and P₂.

Question 16

How to determine which segment receives a lower price in TDPD?

Answer 16

The segment with the more price-elastic demand (more responsive to price changes) will receive the lower price.