Economics of Regulation. Price Discrimination

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1 Economics of Regulation Price Discrimination

2 Definition A. When a seller charges different prices to different customers for the same product (movies theater $6 Adults $3.50 Children) B. When a seller charges the same price to different customers when the cost of serving them are different. (Coffee with cream and sugar costs the same as black coffee).

3 Definition C. In general, price discrimination exists when D. Conditions for price discrimination. Seller must have some degree of monopoly power. Must be able to identify differences in intensity of demand. Must prevent arbitrage.

4 First Degree Price Discrimination A pricing scheme that extracts ALL of the consumer s surplus from the consumer and gives it to the seller.

5 First Degree Price Discrimination (Individual s demand curve) Total Consumer surplus is PCEG. Monopoly pricing takes rectangle from CS to PS with deadweight loss. First Degree PD transfers ALL the CS to PS.

Monopoly pricing takes rectangle from CS to PS with

6 First Degree Price Discrimination Two pricing schemes 1. Offer take it or leave it offer of QC at a total price equal to 0EGQC. Demand curve gives the consumer s willingness to pay. 2. Offer two-part tariff with an entry fee equal to PCEG and a usage fee of PC.

0EGQC. Demand curve gives the consumer s willingness to pay. 2.

7 First Degree Price Discrimination Aggregating individual s demands causes problems - must be able to separate who has the highest willingness to pay for the first unit of the good and so on. This becomes almost perfect price discrimination.

the highest willingness to pay for the first unit of the

8 Second Degree Price Discrimination Seller captures some fraction of CS through multipart pricing or declining block tariffs. Charging the same customer lower prices for additional purchases from the same customer.

9 Second Degree Price Discrimination Buy 2 for $60 or 3 for $80. Lowering the marginal unit s price to $20 gains an extra $10 in profits CS Transferred MC=AC D 2 3

10 Third Degree Price Discrimination Dividing customers into different groups and setting a different price for each group. Also known as market segmentation.

11 D1 is less elastic; gets higher price. D2 is more elastic gets lower price.

12 Welfare Effects A. Perfect PD expands output from the profit-maximizing monopolists and there is no deadweight loss. Output expansion is a necessary but not sufficient condition for welfare improvement. Need to look at income effects which shift demand inward.

13 Public Policy A. Robinson-Patman Act amended section 2 of the Clayton Act - 2(a), 2(b) and 2(f) deal with price discrimination. Section 2(a) prohibits a seller from charging buyers different prices for goods of like grade and quality where the effect may be to weaken competition; 2(b) puts the burden of proof on the defendant; 2(f) prohibits a buyer from knowingly inducing discrimination.

14 Public Policy Three possible legal defenses 1. Cost defense - price differences reflect real differences in costs. 2. Meeting-competition defense - concessions to some buyers to meet an equally low price of a competitor 3. Distress defense - to stave off bankruptcy.

2. Meeting-competition defense - concessions to some buyers to

15 Public Policy C. Primary Line and Secondary Line cases 1. Primary line - injury to competition in the seller s own market 2. Secondary Line - injury to competition in the buyer s market

16 Public Policy - Con s 1. Preservation of small business, clearly a central goal of the act s sponsors is not a proper goal of antitrust. 2. PD not always monopoly induced and harmful. Can be the result of competition and benefit consumers. 3. May actually lead to inefficient rigid prices and suppress price competition.

not a proper goal of antitrust. 2. PD not always monopoly induced and harmful.

17 Public Policy Pro s? 1. Protecting small competitors can serve consumers interests. 2. Protecting small competitors may be 2. Protecting small competitors may be justified on social or political grounds.

18 Basing-Point Pricing Prices for delivered goods set by list price plus a shipping charge determined from a basing point or point of origin regardless of whether the goods were actually manufactured there. 1. Glucose manufacturers used Chicago even though they had plants in Chicago and Kansas City. Another one was in Decatur. 2. Cement Institute - used to disguise price fixing - harder to hide price cuts.

there. 1. Glucose manufacturers used Chicago even though they had plants in Chicago and Kansas City.

19 Cases Morton Salt Utah Pie

Chapter 15: Monopoly WHY MONOPOLIES ARISE HOW MONOPOLIES MAKE PRODUCTION AND PRICING DECISIONS

Chapter 15: Monopoly WHY MONOPOLIES ARISE HOW MONOPOLIES MAKE PRODUCTION AND PRICING DECISIONS Chapter 15: While a competitive firm is a taker, a monopoly firm is a maker. A firm is considered a monopoly if... it is the sole seller of its product. its product does not have close substitutes. The