Price Discrimination: Price Discrimination Monopoly Firms


Slide2: To acquire maximum consumer surplus To gain market power


Definition: A practice whereby similar products are priced differently to different customers or in different markets Definition


Is any difference in price a sign of price discrimination?: Is any difference in price a sign of price discrimination? No, only difference in prices that cannot be explained by the difference in costs Examples: Hardcover vs. paperback books Business class travel. The difference in prices can be larger than the difference in costs Volume discounts that do not reflect economies of scale


Effort to Discriminate: Effort to Discriminate


Effort to Discriminate: Effort to Discriminate Sony Minidisc 60 minute vs. 74 minute versions minidiscs are the same except for a code on the 60 minute version written to stop it from writing the longer time.


Types : Types First Degree Second Degree Third Degree


Some more types: Some more types Intertemporal Peak Load Pricing Two Part Tariff Bundling Tying


First Degree Price Discrimination: First Degree Price Discrimination


Perfect First Degree …: Perfect First Degree … An ideal case of First Degree Price Discrimination. Captures whole consumer surplus.


Perfect First Degree …: Quantity $/Q D = AR MR Pmax MC P* Q* Q** PC Consumer surplus when a single price P* is charged. Variable profit when a single price P* is charged. Additional profit from perfect price discrimination Perfect First Degree …


Imperfect First Degree …: Charging a few different prices based on the estimates of customer’s reservation prices. Imperfect First Degree …


Doctors : Doctors


Lawyers: Lawyers


Accountants: Accountants


Architects : Architects


Car salesperson: Car salesperson


Scholarships: Scholarships


Second Degree …: Practice of charging different prices per unit for different quantities of the same good or service. extract some, but not all of consumer surplus Second Degree …


Second Degree …: Quantity $/Q P0 Q0 P1 Q1 1st Block P2 Q2 P3 Q3 2nd Block 3rd Block Second-degree price discrimination is pricing according to quantity consumed--or in blocks. Second Degree …


Example: Water Bills: Example: Water Bills


Example: Telephone or mobile Bills: Example: Telephone or mobile Bills


Example: electricity bills: Example: electricity bills


Some other examples: Some other examples


Third Degree …: This form of price discrimination divides consumers (with different demand curves) into two or more groups. It is the most prevalent form of price discrimination. Consumer groups can be made based on some observable characteristics. Third Degree …


How to decide price for each group: How to decide price for each group Objective MR1 = MR2 MR1 = MR2 = MC Determining relative price Higher price will be charged to group with low demand elasticity.


Third Degree …: Third Degree … $/Q


note: note Even if third degree price discrimination is feasible it does not always pay to sell to both groups of consumers if marginal cost is rising very readily.


Examples: Examples Discounts to students and senior citizens Publishers charging a higher rate to libraries than to individuals Different airline and train fairs Different labels like premium/non-premium, supermarket label etc.


Firm should be able to prevent resales: Firm should be able to prevent resales Services: it is very difficult to resale a haircut Students are required to show a student ID to enter a football game with a student ticket It is very difficult to buy a car in Canada and bring it into the US


Intertemporal …: Separating the Market With Time Initial release of a product, the demand is inelastic Hard cover books New release of a movie Latest fashions Latest Technology Intertemporal …


Intertemporal …: Separating the Market With Time Once this market has yielded a maximum profit, firms lower the price to appeal to a general market with a more elastic demand Paper back books Movie Tickets Discount rack Intertemporal …


Examples : Examples Plasma screens: Currently at high prices but for how long? Title: Thin-shaped television. Copyright: Getty Images, available from Education Image Gallery


Peak-Load Pricing: Demand for some products may peak at particular times. Rush hour traffic Electricity - late summer afternoons Roses around valentine Hotels are more expensive in summer Peak-Load Pricing


Peak-Load Pricing: Peak-Load Pricing Capacity restraints will also increase MC Increased MR and MC would indicate a higher price MR is not equal for each market because one market does not impact the other market


Peak-Load Pricing: Quantity $/Q MR1 D1 = AR2 MC P1 Q1 Off- load price = P2 . MR2 D2 = AR2 Q2 P2 Peak-Load Pricing


Two-Part Tariffs: Two-Part Tariffs 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. how should the monopolist design its two-part tariff? What is the largest that p1 can be? p1 is the “entrance fee” so the largest it can be is the surplus the buyer gains from entering the market. What should be p2?


Two-Part Tariffs: Two-Part Tariffs


Examples: Examples The sports center charges a fee to join and then a per usage fee. At Disneyland in California and Walt Disney World in Florida, the strategy is to charge a high entry fee and charge nothing for the rides. In 1971, Polaroid introduced its new SX-70 camera. This camera and its film was sold separately. Polaroid could apply a two-part tariff to the pricing of SX-70.


Examples: Innovative pricing: Examples: Innovative pricing Twist: the entry fee T entitles the customer to a certain number of free units. Examples: several blades are usually included in a pack of Gillette razor. Monthly lease fee for a mainframe computer usually includes some free usage before usage is charged. most telephone service plans


Bundling: Bundling Practice of selling two or more products as a package. Demands are negatively correlated. Two types of people: A values $100 for a Word, $120 for Excel B values $120 for Word, $100 for Excel


Examples: Examples In 1939, company MGM, a division of Loews bundled i.e (sold as a package) a classic movie “Gone with the Wind” with a flop of that time “Getting Gertie’s Garter” to gain the maximum profit.


Mixed Bundling: Mixed Bundling Practice of selling two or more goods both as a package and individually. Ideal strategy when demands are only somewhat negatively correlated and/or when marginal costs are significant.


Tying: Tying Practice of requiring a consumer to purchase one good in order to purchase another. Bundling is a common form of tying


Tying as two-part tariff : Tying as two-part tariff During 1950s, Xerox had a monopoly on copying machines but not on paper Xerox required its customers to use only Xerox paper Thereby allowing for two-part tariff to its machines


Tying: Higher profits: Tying: Higher profits During 1950s, IBM required customers who leased its mainframe computers to use paper computer cards made only by IBM. Pricing cards well above marginal cost, IBM was effectively charging the higher prices for computer usage.


Tying: Extending firm’s market power: Tying: Extending firm’s market power Microsoft – have been accused of predatory pricing strategies in offering ‘free’ software as part of their operating system – Internet Explorer and Windows Media Player - forcing competitors like Netscape and Real Player out of the market. Title: Bill Gates speaks at UNIX convention. Copyright: Getty Images, available from Education Image Gallery


Tying: Protecting Cutomer Goodwill: Tying: Protecting Cutomer Goodwill Franchises are often required to purchase inputs from the franchiser. Examples: Mobil Oil requires its service stations to sell only Mobil motor oil, Mobil batteries etc. Untill recently McDonald’s franchise had to purchase all supplies from McDonald’s.


MIND THE GAP: MIND THE GAP


Slide50: So. Why is popcorn more expensive in the movie theaters?