- Slides: 18
Price Discrimination Defined A single-price monopolist charges all consumers the same price. Sellers use price discrimination when they charge different prices to different consumers for one good.
Price Discrimination Defined Many firms can price discriminate, but it is a main feature of monopolies A firm can price discriminate if. 1. They have market power 2. Can separate consumers into groups 3. Can prevent resale
Price Discrimination Defined Usually, sellers who price discriminate are trying to raise prices for consumers who would be willing to pay more and/or lower prices for consumers who are only able to pay less. Although not a monopoly (they are an oligopoly) airlines regularly engage in price discrimination.
The Logic of Price Discrimination Lets say I want to start selling the critically acclaimed book: 3 Blind Kraus(e): A Tale of Physics, Military and Street Law Lets assume it cost me $5 to make each book
The Logic of Price Discrimination Now to make it easy I have two types of customers Type 1: These are the die hard readers. There are currently two type 1 people and are willing to spend $100 for the book Type 2: These are the, “I just want to make Mr. Barber happy so I can pass” readers. There are currently five type 2 people and are willing to spend $15 for the book
The Logic of Price Discrimination If I choose to price discriminate I can make more No price discrimination and I would make $190 by selling only to the type 1 people With price discrimination I would make $240 ($190 from the type 1 people and $50 from the type 2 people So, as a firm, I make the most profit possible AND everyone who wanted the book will be able to obtain it.
The Logic of Price Discrimination Contrary to popular belief, price discrimination actually makes a market more efficient! More consumers are able to purchase the product and there is less surplus lost (deadweight loss). The monopoly firm will just share most of the surplus.
Price Discrimination and Elasticity Because direct price discrimination can be illegal and/or hard to enforce, airlines don’t differentiate prices for specific groups. Instead, they distinguish between groups indirectly with different prices that tap into different price elasticities of demand. For example, fares for return flights before the weekend cost more than flights during or after the weekend because business travelers usually want to be home by the weekend are less sensitive to price.
Perfect Price Discrimination Perfect price discrimination occurs when a monopolist charges each consumer his or her exact willingness to pay —the maximum amount the consumer is willing to pay. As we shall see in the next figure, this would reduce consumer surplus to zero and transform it into a producer surplus. The more different prices the monopolist can charge: 1) the lower the lowest price 2) the more money extracted from consumers
Perfect Price Discrimination Panel (c) shows the case of Panel (a) (b) shows monopolist Panel shows aa monopolist perfect price discrimination: that charges three prices; its that charges two different a monopolist charging each profit, too, is shown by the prices; its their profit is shown by consumer exact shaded area. the shaded area. willingness to pay. By the number Theincreasing monopolist’s profit is of different prices charged, the given by the shaded triangle. monopolist captures more of There is no consumer surplus; the consumer surplus and perfect price discrimination earns moreitprofit. has turned into profit.
Perfect Price Discrimination Note that with perfect price discrimination, there is no deadweight loss. Consumers lose out (there is no consumer surplus) but the total surplus is completely captured by the monopolist as profit.
How Do Producers Price Discriminate? 1) Advance purchase restrictions lower prices for those who purchase in advance or at the last minute, separating those likely/unlikely to shop for better prices. 2) Volume discounts lower price for those buying in bulk, separating those who are likely to be more sensitive to price from those who are not. 3) Two-part tariffs (annual fees at discount clubs) make the first item bought more expensive than later items, making the two-part tariff behave like a volume discount.
Summary and Review 1) What is a monopolist who charges all customers one price called? A single-price monopolist. 2) What is price discrimination? When a firm charges different prices to different customers for the same product.
Summary and Review 3) Why would a firm engage in price discrimination? To increase profit. At the market equilibrium, some consumers are willing to pay more but don’t have to; others would buy if the price were lower. Price discrimination allows firms to charge more to those willing to pay more and charge less to those would only buy it at a lower price.
Summary and Review 4) What is perfect price discrimination? When a monopolist charges ever customer their exact maximum willingness to pay. 5) What is the effect of perfect price discrimination on consumer surplus and monopolist’s profit? Perfect price discrimination converts the entire consumer surplus into producer surplus (or monopolist’s profit).
Summary and Review 6) Is there a deadweight loss to society under perfect price discrimination? Why or why not? No, because the entire total surplus that would exist under perfect competition is converted into profit for the monopoly. 7) What are common methods of price discrimination? 1) Advance purchase restrictions 2) Volume discounts 3) Two-part tariffs
Walkthrough: Free-Response Question 1 1. a. Define price discrimination. b. Why do firms price-discriminate? c. In which market structures can firms price-discriminate? Explain why. d. Give an example of price discrimination. (5 points) 1 point: Price discrimination is the practice of charging different prices to different customers for the same good. 1 point: Firms price-discriminate to increase their profit. 1 point: In order to price-discriminate, firms must be in the monopoly, oligopoly, or monopolistic competition market structure. 1 point: Because rather than being price -takers, firms in these market structures have some degree of market power, which gives them the ability to charge more than one price. 1 point: An example is different prices for movie tickets charged for people of different ages.