T2 1.2: Price Discrimination

Question 1

Define price discrimination?

Answer 1

Selling different units of output at different prices

Question 2

What is first degree price discrimination?

Answer 2

(Perfect PD) Where different units cost different prices, each unit is sold to highest bidder at maximum WTP tf all surplus goes to producer

Question 3

Is 1st PD pareto efficient and why?

Answer 3

Yes - PS is at max, cant add to CS without taking away from CS (see diagram and learn it)

Question 4

What is 2nd degree PD?

Answer 4

Non-linear pricing, the price you pay depends on how much you buy

Question 5

Problem for firms engaging in 2nd PD? and the solution?

Answer 5

Different groups of consumers (high and low demand) should be charged different prices but firm can’t distinguish between them.
Solution is to design ‘price-quantity packages’ so consumers self select themselves into the appropriate packages

Question 6

Using the diagrams in my notes, explain how the firm increases its PS using 2nd degree PD? How does this help the firm?

Answer 6

Firm offers x20 quantity at price A+C, forgoing area B, but inducing high demand consumers to self select themselves into high demand package (consumer surplus on both packages is B tf indifferent, by pricing just below A+C they should choose high demand package)
The firm will now only forgo B rather than B+C!

Question 7

Explain how the firm can improve itself further from the original 2nd degree price discrimination scenario?

Answer 7

By reducing the output targeted at the low demand consumer group, the price they receive on that group falls, but the price they receive on the high demand group increases, tf they lose the triangle but gain the green (see diagram!!!)
For each marginal unit the firm decreases for LD group they lose the LHS of the red triangle, but gain the LHS of the green parallelogram tf TRADEOFF. They continue this tradeoff until equal (see diagram and notes)

Question 8

What is 3rd degree PD?

Answer 8

When each group of people faces a different price, but prices don’t differ by quantity

Question 9

4 assumptions for 3rd PD analysis?

Answer 9

• 2 identifiable groups who get different prices
• Inverse D curve p1(y1) & p2(y2) (=AR curve, price function of Q)
• No resale opportunities (preventing arbitrage at cost lower than additional profit)
• Cost of producing items is equal at c(y1+y2)

Question 10

What must the optimal solution satisfy for 3rd PD and why? What does this therefore imply? (2)

Answer 10

1) MR1(y1)=MC(y1+y2)
2) MR(y2)=MC(y1+y2)
since MC=MR in both markets or producer would change their production level
implies MR1(y1)=MR2(y2)

Question 11

Show that the lowest PED is charged the highest price for 3rd degree PD?

Answer 11

see notes for proof

Question 12

See and learn

Answer 12

linear demand 3rd degree pd in notes

Question 13

If we cannot charge different prices to different groups of consumers, how do we analyse it?

Answer 13

We must sum the demand curves

Question 14

See

Answer 14

Special case in notes

Question 15

2 other pricing strategies?

Answer 15

• Bundling

- Two-part tariffs

Question 16

What is bundling? Give 2 ways it benefits consumers.

Answer 16

Selling a package deal with more than one product together

reduces search costs
highlights complementary goods

Question 17

See example showing bundling

Answer 17

now

Question 18

Why do firms bundle?

Answer 18

It can allow them to maximise revenue

Question 19

What is a two-part tariff?

Answer 19

Pay a fixed ‘entry fee’, then pay as you go on a variable basis (eg. gym, pay for each class)

Question 20

See and understand economics of two part tariffs

Answer 20

NOW

Question 21

Define industry?

Answer 21

All firms that produce a given product (or similar products, if determined by consumers to be subs)

Question 22

Elasticity of a flatter vs steeper D curve?

Answer 22

Flatter - elastic tf lots of similar alternatives

Steeper - inelastic tf fewer alt

Question 23

How is monopolistic competition a) similar to monopoly (3) and b) similar to perfect competition? (2)

Answer 23

a) DWS D curve, not price taker, has market power

b) must compete on P&Q, no entry barriers

Question 24

For a firm in monopolistic competition, how does the increase in firm entry into their market affect their demand? (2)

Answer 24

• D curve shifts inwards (fall in MS)

- D curve becomes flatter (more subs)

Question 25

3 requirements for equilibrium in monopolistic comp? What does this imply?

Answer 25

• Each firm locates at a P&Q along their D curve
• Each firm maxmises profit given their D curve
• Entry forces profit to zero

Implies D curve and AC curve are tangents (draw diagram)

Question 26

What happens if a firm in monopolistic competition deviates from E (break-even)?

Answer 26

Either sell to few units at too high price, P

Question 27

Two points about a firm in monopolistic comp? What does this mean?

Answer 27

Not pareto efficient (P>MC)
Excess capacity (not at min AC curve)

Means if fewer firms there would be high efficiency but less variety

Question 28

Note

Answer 28

Firms can ‘extend the length of the street’ by engaging in product differentiation (see slides 45-49 and 3rd degree PD example 51-56)