Price discrimination Flashcards
Define price discrimination
When a firm charges different prices to different consumers for an identical good/service with no difference in costs of production
What are the conditions necessary for a firm to use price discrimination
- Some sort of monopoly power so that they can set prices (price maker)
- Information available to separate different consumers based on PED e.g. cookies on a website (inelastic = higher price)
- Prevent re-sale of a good where someone buys it for cheaper and sells it for a higher price (market seepage
What is first degree price discrimination
where a firm has information on the price that each consumer is willing to pay for a good/service so they always charge the price that each consumer is willing to pay so therefore there is 0 consumer surplus and it has been turned to monopoly profit
How can we show first degree price discrimination on a diagram
Just a normal supply and demand curve and mark equilibrium price on
Shade area of consumer surplus above equilibrium price and below demand and label how it has been turned to monopoly profits
What is second degree price discrimination
Where a firm has a fixed capacity so lowers the price last minute so their is no spare capacity
e.g. hotel has to pay fixed costs on all their rooms so last minute may lower price to fill all the rooms and contribute towards covering fixed costs instead of keeping price high and leaving rooms empty
How can we show 2nd degree price discrimination on a diagram
- MC is horizontal until Qcap (fixed capacity) as extra cost for each seat/room is constant and then becomes a vertical line as supply can’t increase anymore
- Draw AR and then MC twice as steep, firm produces where MC = MR and mark price P1 off the AR curve
- At this price, there is a difference between Qcap and Q1 as there is spare capacity which the company still has to pay fixed costs on
- Therefore, they lower price to P2 where the AR curve intersects the vertical part of MC curve i.e. where demand is at Qcap
How can you show the benefit to firms and consumers of 2nd degree price discrimination
- Extra revenue = P2 x (Qcap-Q1) which the firm can use to pay off fixed costs
- Extra consumer surplus for consumers paying P2 which can be shown by area above p2 and below AR between Q1 and Qcap
What is 3rd degree price discrimination
Where the producer sells at different prices based on the elasticity of demand
How can you show 3rd degree price discrimination on a diagram
- 2 diagrams, one for inelastic and one for elastic
- MC is the same for both diagrams and is horizontal as extra cost for each seat/room is constant
- AR is much steeper for inelastic than elastic and draw MR twice as steep for each
- For the firm to maximise profits they produce where MC = MR for each, meaning they charge a lower price for elastic
- If they charged the high inelastic demand price for the elastic consumers, they would make less profit as there would be almost no demand from elastic diagram
What are the disadvantages of price discrimination
- Allocative inefficiency as P is far higher than MC so consumers e.g. consumers in 1st degree and inelastic section of 3rd degree are being exploited and losing consumer surplus
- Inequality if consumers being charged higher prices have lower incomes
- Low prices in elastic segment of 3rd degree drives out competitors, making it a monopoly and reducing competition in the market (DWL)
What are the advantages of price discrimination
- Dynamic efficiency benefits due to higher profits
- Higher quantity in 2nd degree and elastic segment of 3rd degree means economies of scale, could lead to lower prices in future
- 2nd degree and elastic segment of 3rd degree means some consumers might benefit
- The higher profits can be used to cross subsidise loss making goods and increase consumer choice
Which have more impact, the advantages or disadvantages of price discrimination
The disadvantages far outweigh the advantages, mainly due to the allocative inefficiency being very bad for consumers
The benefit to some consumers is not close to the loss for others
