Transcript Price Discrimination: The Logic

Price Discrimination: The Intuition
Get those who will pay to pay
Buyers with inelastic demand
– They’re not scared off by high price
– So charge them high price
Buyers with elastic demand
– They buy lots at low price
• Does low price cover cost?
– So charge them low price
WARNING: Beware of Resale!
How to Price Discriminate:
Let Us Count the Ways

Demographics
– Senior discounts
– Military discounts
– Student discounts
– Kids eat free

Time of Day, Week, Year
– Matinee tickets
– Airline pricing / Phone pricing
– Weekday / weekend hotel rates
• Rack rate for “special” guests
– Holiday travel
WARNING: Beware of Resale!
How to Price Discriminate:
Let Us Count the Ways

Early Adopter Pricing
– The Next New Thing
– Hardcover/ softcover
– End-of-season clearance

Product Differentiation
– Brand name / generics
– Business / coach
– Factory outlets
WARNING: Beware of Resale!
How to Price Discriminate:
Let Us Count the Ways

Pricing Complements
– Razors / Razor Blades
– Polaroid Camera / Polaroid Film
– Vegas Comps


Buyers’ Clubs
Coupons
WARNING: Beware of Resale!
Price Discrimination: The Degrees

Third Degree: Product Differentiation
– Time of purchase
– Place of purchase
– Hardcover / softcover

Second Degree: Non-Linear Pricing
– Buyers’ clubs
– Entry fee
– Quantity discounts
– Quantity premiums

First Degree: Extract All Surplus
– Tailored fees and discounts
– Early adopter pricing
– Complement pricing
Schemes to Get It All
 Set
unit price equal to marginal cost
– Buyer buys the most at this lowest
possible price
– Buyer gets maximum consumer surplus at
this lowest possible price
“Tax” away consumer surplus with
an entry fee, F
Schemes to Get It All

Imagine a buyer with a money-left-over utility
function: U(x,m) = U(x) + m
 At buyer optimum:
MUx/Px = MUm/Pm= 1/1 = 1
Buyer will purchase x to point where MUx = Px
Buyer’s MUx curve describes buyer’s demand
Px
Maximize Consumer Surplus
Then “tax” it away!
C.S
Px*
MC
x
Getting It All
Firm sets price to its marginal cost
 Firm
can experiment with different
fees, F
– In business-to-business sales,
“consumer surplus” is the buyer’s
profit
• Buyer profit (at price equals seller’s
marginal cost) can be estimated
• Different buyers (franchisees) can be
charged different fees