Price Discrimination What is price discrimination? the practice of charging different prices to different customers for similar goods

Transcription

1 ECMC41 - Week 5 Price Discrimination What is price discrimination? the practice of charging different prices to different customers for similar goods Why do sellers want to charge multiple prices? Look at single price monopoly. Is the singleprice monopolist missing out on possible profit opportunities?

2 Under the right conditions, the monopolist can turn (at least part of) consumer surplus and deadweight loss into additional revenues. What s the problem for the single price monopolist? MR = dtr/dq = d(pxq)/dq =(dp/dq x Q) + (dq/dq x P) = P + (dp/dq x Q) In words, single-price monopolist has to lower the price in order to sell more output. Price discrimination offers an opportunity to sell at different prices.

3 3 broad types of price discrimination: 1 st degree perfect price discrimination. Different price charged for each unit sold to each customer (reservation price). Monopolist takes all the consumer surplus. Can achieve same results with sale of fixed amount of good at a take-it-or-leave-it price or with two-part pricing (two-part tariff). Also called personalized price discrimination. 2 nd degree different price for purchasing different number of units of good (or goods with slightly different characteristics or quality); same deal offered to each customer. Customers must self-select into buying a certain package (and therefore self-select into paying a different price!). Also called versioning.

4 3 rd degree market segmentation different prices for different types of consumers (must be readily identifiable). Same deal not offered to each customer. Relies on different demand elasticities. Also called group pricing. There are also bundling and tying effectively these are forms of price discrimination. bundling offering goods for sale combined in bundles, rather than separately. E.g., Microsoft Office, CD in album form. Tying is a general term referring to a connection between products. Bundling is one form of tying. But printers and print cartridges are another. Printers are generally sold cheap, but they require regular feeding with expensive printer cartridges that are producer-specific. Microsoft offered Windows 98 with Internet Explorer tied in to this purchase.

5 We will discuss 3 rd, then 2 nd, then 1 st. 3 rd degree Group pricing students and senior citizen bus tickets, men s and women s haircuts, textbook sales in Canada and India, libraries vs. individuals for academic journals (no resale possible). Consumers with different demand elasticities must be readily identifiable and separable. Draw diagram of segmented markets:

6 Imagine a monopoly company selling satellite signals in Vancouver and Toronto. The markets are naturally segmented. Demand in Vancouver is given by P 1 = Q 1. Demand in Toronto is given by P 2 = Q 2. Total cost to the company of transmitting and providing the signals is given by TC = 10, Q. (a) Imagine first that a government regulator requires this firm to sell satellite signals at a uniform price in both markets. What will be the profit-maximizing price and quantity for a single-price monopoly? How much profit will the single-price monopolist earn? What will be the total consumer surplus, and the consumer surplus received by consumers in each of these markets separately?

7 First, we need to find the total (joined) demand curve. Add quantities demanded over the two markets. P 1 = Q 1 so Q 1 = P 1 P 2 = Q 2 so Q 2 = P 2 Q T = P Or P = Q. This is the total demand curve (or is it? Check by drawing the demand curves and summing them graphically)

8 Calculate the monopoly output and price. Calculate the profit. Calculate CS for each market and in total. What is the deadweight loss?

9 Now, calculate profit-maximizing price and quantity if market segmentation is possible. What is profit? CS in each market? How does CS compare to the single-price situation? What is deadweight loss?

10 2 nd degree (versioning)- Quantity: 12 vs. 2 rolls of toilet paper, jumbo size vs. regular size cereal, family pack of chicken pieces vs. two in a pack. Quality or Characteristics: airline tickets for economy vs. business class, hardback and paperback books, coupons Note: the same menu of prices/packages is offered to all customers. Not different prices for different customers. Customers self-select. Two types of customers (business vs. economy, rich vs. poor, keeners vs. newbie s etc.). Call them Type A (lower demand) and Type B (higher demand). We assume all Type A consumers have identical demand curves and all Type B consumers have identical demand curves, so we can show on a graph 1 representative Type A consumer and 1 representative Type B consumer.

11 Producer is a monopolist. Cannot distinguish the low demand from the high demand customers (no identifying markers). Producer s objective is to design a set of price-quantity packages that will encourage self-selection. Wants the high demand consumers to choose high-priced package. Low demand consumers will choose the lowpriced package. For simplicity, assume MC = AC = 0 to focus only on demand side of this problem.

12 $ per unit B Type A demand B* A C Type B demand A* Q* A Q A Q B Quantity

13 What is the best set of price-quantity packages that this monopolist can offer? Try three possibilities: (1) Sell Q A on a take-it-or-leave-it basis for the total area under the Type A demand curve. Sell Q B on a take-it-orleave-it basis for the total area under the Type B demand curve. (2) Sell Q A on tioli basis for total area under Type A demand curve. Sell Q B on tioli basis for price of A + A* + C (3) Sell Q* A on tioli basis for price of A. Sell Q B on tioli basis for price of A + A* + B* + C (4) Is there a better price-quantity package? Does the best package depend partly on the number of Type A and Type B consumers?

14 Look on the web for algebraic example. You need to be able to do this algebraically. (also look on intranet for updated problem sets) What happens if we reinterpret quantity as quality? What about business class vs. economy? What about disabling the math co-processor on 486 chips? Hardback vs. softback books. Coupons.

15 Take a simple example. There is one Type A consumer and one Type B consumer. Type A s demand curve is P = 100 Q. Type B s demand curve is P = Q. Cost of production is zero. (a) What price could the producer charge for 100 units of the good to the Type A consumer? With this price available for 100 units, what price could the producer charge for selling 160 units of the good to the Type B consumer? (b) Answer the same questions for 60 units of the good (Q* A )

16 $ per unit V W B X Type A demand B* Z Y A Type B demand A* C Q* A Q A Q B Quantity

17 Calculate the value of all the relevant points on the graph and then calculate the dollar value of different areas. V is 120 W is 100 X = (60) = 75 Y = = 40 Z = (100) = 45 Q* A = 60 Q A = 100 Q B = 160 Therefore area A + A* = 100 x 100/2 = $5,000 Area A* = 40 x (100-60)/2 = $800 Therefore, area A = = $4,200 Area C = 45 x ( )/2 = $1,350 Area A* + B* + C = 75 x (160-60)/2 = $3,750 Therefore, area B* = = $1,600 Area A + A* + B + B* + C = 120 x 160/2 = $9,600 Area B = = $1,650

18 We can now answer the questions: the producer could sell 100 units to Type A at a price of $5,000. To encourage self-selection, the price of 160 units for Type B consumer would at maximum be $6,350 The producer could sell 60 units to the Type A consumer at a price of $4,200. Then the price of 160 units would be $7,950. Profit in the first case would be (since there are only two consumers) = $11,350 Profit in the second case would be = $12,150

19 Conclusions: (1) Second-degree price discriminator has to give Type B consumers enough consumer surplus so that they will choose (self-select) the high-priced package. (2) By squeezing the low-price consumers, the price-discriminator can get more from the high-price consumers.

20 1 st degree (personalized) examples: used car purchasing, or new car; oriental bazaar buying a rug. Small town doctor or other professional. Colleges and universities in U.S.(?) Imagine the demand for used cars in a small town. There is one used car dealer. There are 10 potential purchasers of used cars. The first one is willing, at maximum to pay $10,000. The second is willing, at maximum, to pay $9,000. The third will pay $8,000, and so on down to the 10 th potential purchaser in town, who is willing, at maximum, to pay $1000.

21 If the marginal cost of used cars to the dealer, including his marginal costs of selling, is MC = $5,000, and he has fixed costs of $10,000 for the business, how may cars will the dealer sell (presuming he wishes to sell as many cars as it makes sense to sell), and what will be his profit? How does this compare to the efficient result? What is the amount of deadweight loss?

22 A different form of perfect price discrimination When every potential consumer has the same demand curve (e.g., local telephone calls, amusement park rides). Imagine that every person s demand curve for telephone calls is given by P = Q, where P is measured in dollars and Q is number of calls per month. Imagine that the marginal cost of providing telephone service is $1 per call, and that telephone services are supplied by only one company (no close substitutes, entry blocked). How should the monopolist price telephone services to earn the most profit? (2 possibilities) (a) take-it-or-leave-it pricing (b) charge marginal cost per unit and an entry fee (two-part tariff) e.g., sports clubs, amusement parks, printers, razors, copier and maintenance contract etc.

23 How many calls will each consumer make per month? Are these results efficient?

24 Bundling makes sense when consumers have heterogeneous demands and firms cannot separate consumers to price discriminate. Bundle items together because they are more valuable together than separately. Cable service: bundling of channels into groups. You cannot buy access to individual channels; they are bundled. HBO History Sports Tom: $15 $3 $7 Dick: $2 $20 $4 Harry: $6 $8 $12 Assume cost of production is zero and that cable company has option of selling each channel separately at the same price to everyone, or of bundling channels together and selling the bundle of three at the same price to everyone. How much will each option sell for, and which alternative is most profitable?