Transcript Price Discrimination

What is Price Discrimination?
• Price discrimination involves market segmentation
• Practiced by monopolists or any firm with price setting power
• Does not occur in perfectly competitive markets
• A firm price discriminates when it charges different prices to
different consumers for reasons that do not reflect cost
differences
• This involves extracting consumer surplus from buyers and
turning this into additional revenue and profit
• A business is exploiting the fact that consumers have a
different willingness and ability to pay for goods and services
Conditions Required for Price
Discrimination
• The firm must have some price-setting power in at least one
market (I.e. operating in an imperfectly competitive market)
• There must be at least two consumer groups a with different
price elasticity of demand
• The firm should be able to identify consumers in each group,
and set prices differently for consumers in the groups (requires
sufficient information)
• The firm must prevent consumers in one group selling to
consumers in the other (no market arbitrage or market
seepage)
1st Degree (Perfect) Price
Discrimination
• Involves perfect segmentation of the market by the supplier
• Every customer is charged his or her “willingness to pay”
• So there is no consumer surplus in the transaction
• The monopolists’ demand curve becomes the marginal
revenue curve, i.e. you do not have to lower the price to the
higher value customers in order to sell more!
• More goods are sold; but price is higher to some customers
• Total output is higher than under normal profit-maximization
1st Degree Price Discrimination
Price
P1
AC = MC
AR (Market Demand)
Marginal Revenue
Q1
Quantity
Normal profit maximising price and output is P1 and Q1 (where
marginal revenue meets marginal cost)
1st Degree Price Discrimination –
Equilibrium Output
Price
Pmon
AC = MC
AR= market demand
MR
Qm
Qe
Quantity
Normal profit maximising price and output is P1 and Q1 (where MR=MC)
With perfect price discrimination, output may rise to Qe where MC meets
the demand curve
Extracting the Consumer Surplus
Price (P)
P2
P1
AC = MC
P3
AR (Market Demand)
MR
Q2
Q1
Q3
Quantity of Output (Q)
Extracting the Consumer Surplus
Price (P)
Equilibrium output with perfect
price discrimination – the
monopolist will sell an extra unit
providing that the next unit
adds as much to revenue as it
does to cost
P2
P1
AC = MC
P3
AR (Market Demand)
MR
Q2
Q1
Q3
Quantity of Output (Q)
Each consumer is charged what they are willing to pay – the market is segmented
and the seller aims to extract the consumer surplus and turn this into revenue and
extra (marginal) profit
Examples of 1st Degree
Discrimination
• First degree discrimination takes place when bartering exists
between buyers and sellers
• The bid and offer system in the housing market where
potential home buyers put in an offer on an individual
property
• Negotiating prices with dealers for second hand cars
• Haggling for the price of a hotel room
• Antiques fairs and car boot sales!
Excess Capacity Pricing?
• Excess capacity pricing exists when sellers try to off-load their
spare output to buyers
• Examples
– Cheaper priced restaurant menus at lunchtime
– Cinema and theatre tickets for matinees
– Hotels offering winter discounts
– Car rental firms reducing prices at weekends
• Not always the case that prices are lower if consumers delay
their purchases
– Advance discounts on season tickets for soccer clubs
– Discounts for early booking of package holidays
3rd Degree : Market Separation
• Separate markets based on some identifiable characteristic
• Monopolist seeks to maximize profits in each sub-market
• Sell additional output in elastic market (lower price)
• Reduce sales in inelastic market (increase price)
• Prevent resale of the good or service
• Examples of Market Separation / Segmentation
– Discounts to Seniors / Senior Citizens
– Different prices for students and adults for bus travel
– Gender pricing in some bars/night clubs
Third Degree Price Discrimination
Market A
Market B
Price
Price
ARa
MRa
Quantity
MRb
ARb
Quantity
Third Degree Price Discrimination
Market A
Market B
Price
Price
MC=AC
ARa
MRa
Quantity
MRb
ARb
Quantity
Third Degree Price Discrimination
Market A
Market B
Price
Price
Pb
Pa
MC=AC
ARa
MRa
Quantity
MRb
ARb
Quantity
Third Degree Price Discrimination
Market A
Market B
Price
Price
Pa
MC=AC
ARa
MRa
Quantity
MRb
ARb
Quantity
Third Degree Price Discrimination
Market A
Market B
Price
Price
Profit from selling to
market A – relatively
elastic demand –
lower price
Pa
MC=AC
ARa
MRa
Quantity
MRb
ARb
Quantity
Third Degree Price Discrimination
Market A
Price
Market B
Profit from selling to
market A – relatively
elastic demand –
lower price
Price
Pb
Profit from selling to
market B – relatively
inelastic demand –
higher market price
Pa
MC=AC
ARa
MRa
Quantity
MRb
ARb
Quantity