Transcript Lecture 5 Slides

Lecture 5
2nd Degree Price Discrimination
AEM 4160: STRATEGIC PRICING
Prof. Jura Liaukonyte
1
Dyson
SECOND DEGREE PRICE DISCRIMINATION
2
Dyson
Second-degree price discrimination
 What
if the seller cannot distinguish between buyers?
 perhaps they differ in income (unobservable)
 Then
the type of price discrimination just discussed is
impossible
 High-income buyer
will pretend to be a low-income buyer
 to avoid the high entry price
 to pay the smaller total charge
3
Dyson
3
Second-degree price discrimination
Essence of second-degree price discrimination
• It is “like” first-degree price discrimination
– the seller knows that there are buyers of different types
– but the seller is not able to identify the different types
Seller has to compromise
• Design a pricing scheme that makes buyers
– reveal their true types
– self-select the quantity/price package designed for them
4
Dyson
4
Second-degree price discrimination
• Firms typically offer a list of different prices to consumers
allowing the consumers to self-select.
• Also called VERSIONING pricing strategy: companies sell
variations of a product or service at different prices to
different groups of customers.
• Create versions of a product to appeal to different types of
buyers. Customers then choose the version that best
meets their needs.
• Distribute a physically similar product under different brand
names,
– E.g. GAP, Old Navy, Banana Republic
– Filene’s Basement, TJMaxx, Marshalls
5
Dyson
Second-degree price discrimination
• Will the monopolist always want to supply both types of
consumer?
6
Dyson
6
Second-degree price discrimination
• Will the monopolist always want to supply both types of
consumer?
• There are cases where it is better to supply only highdemand types
– high-class restaurants
– golf and country clubs
7
Dyson
7
Second-degree price discrimination principles
Page
8
• Induce customers to select into high and low price groups
themselves.
• Key constraint: you can’t make the inexpensive version
too attractive to those willing to pay more.
• If there aren’t many customers in the low-valuation group,
you may want to ignore this group, since selling to it forces
you to lower the price to the high valuation group.
8
Dyson
Some examples….
9
Dyson
Second-Degree Price Discrimination
Example
Self Selection
• Movies

HD vs. SD – Value of high definition
• TurboTax

Options: Individual with bigger need
• Health Clubs

Off peak hours discount: busy individual vs.
student
• Getty Images

Resolution – Professional vs Casual

Self select price per unit based on quantity
• Buy Bulk at Sam’s
10
Dyson
Page
11
More types of second degree price discrimination
Example
Self Selection

Intertemporal

High Valuation users are less patient

Quantity Discounts

High valuation consumers pay high
price for higher volume

Multiple two-part
tariff

Example: cell phone plans with monthly
and per minute fees – Separate
between high and low volume users
11
Dyson
Bulk Discounts: Second-Degree Price Discrimination
In some markets, consumers purchase
many units of a good over time
Demand declines with increased
consumption
Price Discrimination: Charge different
prices to increase volume
Charge different prices per unit for
different quantities of the same good
12
Dyson
Quantity
Discounts
Block Pricing:
Charge different
price for blocks of
a good e.g. Electric
Power
Takeaways

Firms would prefer to use perfect (aka first-degree) price
discrimination, but this may be impossible.

Second-degree PD induces customers to sort themselves into
groups.

Recall the no arbitrage constraint—consumers can’t resell to
others.

Price discrimination and other advanced pricing strategies
are powerful tools; you now have the economic models to
understand them.
13
Dyson
Page
13
Example: Tablet Industry
14
Dyson
Intertemporal pricing
• People value things differently depending on the point in
time they will receive it
– Value now > Value later
– eReader and Tablet companies exploit this discrepancy by marking up
their product upon introduction
– Capture the consumer surplus of early-adopters
– They later lower their prices to reflect the reduction in value that occurs
when the product leaves the initial market entry stage and more
consumers begin to enter the market
15
Dyson
Intertemporal Pricing: eReaders
16
Dyson
Intertemporal Pricing: eReaders
17
Dyson
Intertemporal Pricing: eReaders
18
Dyson
Example: Airline Industry
19
Dyson
2nd Degree Price Discrimination
• Price Dispersion
– Variation in prices for the same item
• Versioning
– Variations of a product or service at different prices to different groups of
customers
• First Class vs. Coach seating
20
Dyson
Price Dispersion
• The expected difference in fares paid is 36%
• Airlines likely to have 20 or more different fares on one
given flight
21
Dyson
Example: Ski Industry
22
Dyson
Product Differentiation
• A form of second degree price discrimination
• Provide customers with many options and they choose
what to purchase
• Ski resort industry offers a variety of products and services
in order to:
– Meet consumer needs
– Maximize revenue
– Maximize producer surplus
– Increase customer base
23
Dyson
Product Differentiation
24
Dyson
Ski Pass Differentiation
• Type of ski pass
– Full day pass
– Half day pass
– Night pass
• Length of ski time
– One day pass
– Weekend pass
– Week pass
– Season pass
25
Dyson
Example: Coupons
26
Dyson
Coupons
Grocery Trends (2009)
Coupons
Distributed
+12%
Coupons Redeemed
+19%
Internet Coupons
+83%
75% of coupon users say coupon
had at least some influence on their
decision to purchase a new product
27
Dyson
Coupons
• A form of second-degree price
discrimination
• Enables retailers to attract
informed customers by
discounting
28
Dyson
Coupon Overview
29
Dyson
Coupon Usage Distribution
30
Dyson
Coupons and Income
• Trends relating to newspaper readership provide
some explanation for this imbalance.
• According to Scarborough Research, better
educated and higher income households buy and
read the newspaper more than others and
newspapers remain a key vehicle for delivering
coupons.
• Additionally, promotions are generally targeted in
areas with more affluent consumers.
In essence, the better educated and more affluent
consumers are much better at looking for deals as
they recognize the value of money.
31
Dyson
Summary : Second-degree price discrimination
principles
• Induce customers to select into high and low price groups
themselves.
• Key constraint: you can’t make the inexpensive version
too attractive to those willing to pay more.
• If there aren’t many customers in the low-valuation group,
you may want to ignore this group, since selling to it forces
you to lower the price to the high valuation group.
32
Dyson
Two-Part Tariffs
33
Dyson
More types of second degree price discrimination
• Multiple two-part tariffs
– Examples of two-part tariffs: cell phone plans with monthly and per minute
fees.
– Idea: separate between low volume users and high volume users.

A two-part tariff is a lump-sum fee, p1, plus a price p2 for each
unit of product purchased.

Thus the cost of buying x units of product is p1 + p2x.

Q: What is the largest that p1 can be?
34
Dyson
Two-Part Tariffs
• p1 + p2x
• Q: What is the largest that p1 can be?
• A: p1 is the “entrance fee” so the largest it can be is
the surplus the buyer gains from entering the market.
• Set p1 = CS and now ask what should be p2?
The monopolist maximizes its profit when using a two-part tariff by
setting its per unit price p2 at marginal cost and setting its lumpsum fee p1 equal to Consumers’ Surplus.
35
Dyson
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
36
Dyson
18-36
Two-part pricing
• Jazz club serves two types of customer
– Old: demand for entry plus Qo drinks is P = Vo – Qo
– Young: demand for entry plus Qy drinks is P = Vy – Qy
– Equal numbers of each type
– Assume that Vo > Vy: Old are willing to pay more than Young
– Cost of operating the jazz club C(Q) = F + cQ
37
Dyson
Two-Part Pricing
$
Vi
The entry charge
converts consumer
surplus into profit
Set the unit price equal
to marginal cost
This gives consumer
surplus of (Vi - c)2/2
Set the entry charge
to (Vi - c)2/2
c
MC
MR
Vi - c
Vi
Quantity
Profit from each pair of Old and Young is now d = [(Vo – c)2 + (Vy – c)2]/2
38
Dyson