Transcript price discriminating - McGraw Hill Higher Education

Chapter 18
Pricing Policies
McGraw-Hill/Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All Rights Reserved.
Main Topics
Price discrimination: pricing to extract
surplus
Perfect price discrimination
Price discrimination based on observable
customer characteristics
Price discrimination base on selfselection
18-2
Price Discrimination: Pricing to
Extract Surplus
 Monopolist’s profit would be larger if he could solve two
problems
 Consumers who buy some of the product receive some
consumer surplus
 Monopolist could increase profit if he could charge them a
higher price
 Consumers aren’t buying some units that they value
less than the monopoly price but more than marginal
cost
 Monopolist could increase profit if he could charge these
buyers less for those units of the good
 Monopolist might be able to do better by price
discriminating: charging different prices for different
units of the same good
18-3
Price Discrimination: Pricing to
Extract Surplus
 To be able to price discriminate:
 A firm must have some market power
 If not, a price above marginal cost will result in zero sales
 The good or service must be difficult to resell
 Otherwise few sales will occur at the higher price
 Firm must also be able to distinguish sales for which the
purchasers have a high willingness to pay from those they
have a low willingness to pay
 A monopolist can perfectly price discriminate if he
knows perfectly the customer’s willingness to pay for
each unit he sells and can charge a different price for
each unit
18-4
Price Discrimination: Pricing to
Extract Surplus
 Usually, a firm does not perfectly know a customer’s
willingness to pay
 Two different ways to distinguish purchases for which
the customer has a high vs. a low willingness to pay
 Price discrimination is based on observable customer
characteristics when a firm can distinguish
consumers with a high vs. low willingness to pay
 Price discrimination is based on self-selection when
the firm offers a menu of alternatives
 Designed so that customers will make choices based on their
willingness to pay
 In quantity-dependent pricing, the price a consumer
pays for an additional unit depends on how many units
she has bought
18-5
Perfect Price Discrimination
 Under perfect price discrimination, the firm knows
perfectly its customers’ willingness to pay
 Can set the price for each individual consumer equal to
her willingness to pay
 Marginal revenue curve coincides with the market
demand curve
 Profit-maximizing sales quantity occurs where the
market demand curve crosses the marginal cost curve
 Monopolist produces the same quantity as would occur
in a competitive industry
 Each consumer consumes the same quantity as they would
under perfect competition
 No deadweight loss
18-6
Figure 18.2: Perfect Price
Discrimination Sales Quantity
18-7
Two-Part Tariffs
 Two-part tariffs are another quantity-dependent pricing
plan that allows a perfectly discriminating monopolist to
maximize profit
 With a two-part tariff, consumers pay a fixed fee plus
a separate per-unit price for each unit they buy
 Examples: amusement parks, rental car companies
 Commonly used by monopolists and firms whose
market power falls short of monopoly
 Advantage is simplicity: name just two prices
 To maximize profit, set per-unit charge equal to
marginal cost
18-8
Figure 18.4: Profit with a
Two-Part Tariff
 Per-unit charge equals
marginal cost
 Fixed fee is the
consumer’s surplus at
that per-unit price
 Maximizes aggregate
surplus
 Leaves the consumer no
surplus
18-9
Price Discrimination Based on
Observable Characteristics
 Most often a firm’s ability to price discriminate is
imperfect
 May be able to sort consumers into rough groups
based on observable characteristics
 But know no more about their willingness to pay
 Cannot engage in quantity-dependent pricing because cannot
track purchases
 Example: small town movie theater with four consumer groups
(adults, seniors, students, kids)
 To maximize profit consider each group’s demand
curve separately
 Set price to maximize profit earned from that group
18-10
Price Discrimination Based on
Observable Characteristics
 Set different prices whenever the groups have different
elasticities of demand
 Charge a higher price to groups with less elastic
demand
 Generally the group that will face the higher price is the
one with the less elastic demand at the profitmaximizing no-discrimination price
 Starting at that price, monopolist will:
 Raise the price of the less elastic group
 Lower the price of the more elastic group
 Can find optimal prices and quantities for each group
using algebra
18-11
Figure 18.5:Profit-Maximizing
Price to Two Groups
18-12
Welfare Effects of Imperfect
Price Discrimination
 Profit is at least as large with discrimination as without
 Can always charge every group the same price, won’t charge
different prices unless it benefits the firm
 Price discrimination affects different groups of consumers
differently
 Worse off it my price rises as a result of discrimination, better off if it
falls
 Two main effects on consumer and aggregate surplus:
 Different consumers pay different prices, inefficient because a
consumer who faces a low price and decides to buy may have a
lower willingness to pay than a consumer who faces a high price and
decides not to buy
 May encourage the monopolist to sell more, increase both consumer
and aggregate surplus
 Opposing effects can combine to either raise or lower consumer
and aggregate surplus
18-13
Welfare Effects of Imperfect
Price Discrimination
In Figure 18.7, total consumer surplus is
smaller with discrimination
The gain to college students is smaller than the loss
to other adults
Aggregate surplus is also smaller with
discrimination
Gain in profit ($800) is smaller than the loss in
consumer surplus ($1,200)
The number of tickets sold is the same
But inefficiently distributed with discrimination
18-14
Figure 18.7: Welfare Effects of
Price Discrimination
18-15
Price Discrimination and
Market Power
In a competitive market, firms can’t price
discriminate
Price discrimination is a sign of a market that is not
perfectly competitive
Can be difficult to determine whether price
discrimination exists in a market
Different prices may reflect cost differences
Market does not have to be very far from
perfectly competitive to exhibit discrimination
Oligopolists may price discriminate more than
monopolists
18-16
Price Discrimination Based on
Self-Selection
Often firms cannot distinguish between groups
of consumers based on observable
characteristics
Price discrimination may still be possible
Offer a menu of alternatives
If properly designed, customers with different
willingness to pay will choose different alternatives
A common practice
Examples: supermarket discounts for shoppers who
clip coupons, wireless phone companies with
multiple calling plans
18-17
Quantity-Dependent Pricing and
Self-Selection
 Recall that a perfectly discriminating monopolist
maximizes profit with a two-part tariff
 This level of profit is not achievable when consumers’
characteristics are not directly observable
 If given the choice between two plans with the same
per-minute price, all consumers will opt for the lowdemand (low fixed fee) plan
 Consumers will not self-select based on willingness to pay
 The monopolist can often do better by raising the perunit charge above its marginal cost
 Can do even better by offering a menu of different twopart tariffs
18-18
Figure 18.9: Two-Part Tariff with
Two Types of Consumers
18-19
Clearvoice Wireless Example
 Clearvoice is a wireless telephone monopolist in a rural
area
 Two types of consumers, high-demand and lowdemand
 Distinct monthly demand curves for wireless minutes for each
group
 Clearvoice’s marginal cost is 10 cents
 If could observe consumer characteristics, would offer
two-part tariff with 10-cent per-minute price
 Fixed fee for low-demand customers: $8
 Fixed fee for high-demand customers: $40.50
18-20
Profit-Maximizing Two-Part Tariff
 Suppose Clearvoice wants to offer a single two-part
tariff
 Per-minute price of 10 cents and monthly fee of $40.50
 High-demand customers accept
 Low-demand customers reject
 Per-minute price of 10 cents and monthly fee of $8
 All consumer accept
 Which plan is better?
 If there are a large number of low-demand customers, $8
monthly fee is better
 May be even more profitable to raise per-minute fee
above marginal cost
18-21
Profit-Maximizing Two-Part Tariff
 If the monopolist plans on selling to both types of
consumer it is always profitable to raise the per-unit
price at least a little above marginal cost
 Regardless of the types’ relative proportions
 Would like to extract some of high-demand consumers’
surplus without changing surplus of low-demand
consumer (already zero)
 Raise per-unit price to get more surplus from high-demand
consumers
 Adjust fixed fee so low-demand consumers’ surplus is
unchanged
 The smaller the faction of low-demand consumer, the
more worthwhile it is to raise the per-unit price
 Deadweight loss from low-demand consumers increases
18-22
Figure 18.10: Benefits of Raising
the Per-Minute Charge
18-23
Using Menus to Increase Profit
Can do even better by offering a menu of twopart tariffs, each designed to attract a specific
type of consumer
Can eliminate some deadweight loss by introducing
a second tariff plan
Extract more surplus from high-demand consumers
by making the low-demand plan less attractive to
high-demand customers
18-24
Eliminating Deadweight Loss of
High-Demand Consumers
 Suppose Clearvoice offers a pair of two-part tariffs
 One designed for low-demand consumers:
 Per-minute price of 20 cents, fixed fee of $4.50
 Second option intended to attract high-demand
customers:
 Per-minute price of 10 cents, equal to Clearvoice’s marginal
cost
 Fixed fee should be set as high as possible without causing
high-demand consumer to choose the other plan
 With menu of plans:
 Firm profits are higher from high-demand consumers
 Profits from low-demand consumers are the same
 Deadweight loss from high-demand consumers is eliminated
and extracted as surplus
18-25
Figure 18.11: Menu of
Two-Part Tariffs
18-26
Making the Low-Demand Plan
Less Attractive
 Can increase profit even more by making the lowdemand plan less attractive to high-demand
consumers
 That plan determines the fixed fee the firm can charge a highdemand consumer
 It is the level that makes the high-demand consumer indifferent
between the two plans
 Limit the number of minutes a consumer can purchase
in the 20-cent-per-minute plan
 Set the limit equal to the number low-demand consumers want
 Will have no effect on value a low-demand consumer derives
 Make the plan less attractive to high-demand customers
 Will increase the fixed fee Clearvoice can charge high-demand
consumers for the 10-cent-per-minute plan
18-27
Figure 18.12: Capping Minutes
18-28
Menu of Two-Part Tariffs
A firm can often profit by offering a menu of
choices
Designed for different types of consumers
To maximize its profits, firm should try to make
each plan attractive to one group only
And unattractive to other consumer groups
Firm benefits from setting the per-unit price in
the plan intended for consumers with the
highest willingness to pay equal to the marginal
cost
Eliminates deadweight loss for those consumers
18-29