Pricing Perloff Chapter 12 Why price discriminate

Pricing Perloff Chapter 12

Why price discriminate • Downward sloping demand curve implies that consumers are prepared to pay differing prices for the good. • Two reasons for higher profit: – Higher price to those prepared to pay it; – More sales through the lower price to those unwilling to pay the uniform price.

Conditions for price discrimination • Market power – Ability to change the price it charges • Consumers must differ either: – in their individual willingness-to-pay for different units of the good – in different consumers having different willingness-to-pay for the good • Prevent resale

Types of price discrimination • Perfect (first degree): – Each unit of the good is sold at its maximum price. • Quantity (second degree): – Price determined by the volume of sales. • Multimarket (third degree): – Different groups charged different prices.

p, $ per unit Perfect price discrimination 6 5 e 4 MC 3 Demand, Marginal revenue MR 1 = $6 MR 2 = $5 MR 3 = $4 2 1 0 Source: Perloff 1 2 3 4 5 6 Q, Units per day

The efficiency of p, $ per unit p perfect price discrimination 1 A ps B pc =MC c es C E D MC ec MCs Demand, MR d MC 1 MR s Qc= Q d Source: Perloff Q, Units per day

Quantity discrimination • firm does not know which customers have highest reservation prices • firm might know most customers are willing to pay more for first unit (demand slopes down) • firm varies price each customer pays with number of units customer buys – price varies only with quantity: all customers pay the same price for a given quantity • Various forms – Bulk discounts – Block pricing

Block pricing (individual consumer) (a) Quantity Discrimination p 1, $ per unit 90 70 (b) Single-Price Monopoly p 2 , $ per unit 90 A= $200 60 C= $200 50 B= $1, 200 30 D= $200 E = $450 F = $900 m 30 G = $450 m Demand MR 0 Source: Perloff 20 40 90 Q, Units per day 0 30 90 Q, Units per day

Multimarket pricing (a) Japan (b) United States p , $ per unit J p US , $ per unit 4, 500 3, 500 CSUS p. US = 2, 500 CSJ p. J = 2, 000 DJ p. US p. J DWLJ 500 MC DWLUS 500 MRJ 0 Source: Perloff QJ = 3, 000 7, 000 QJ, Units per year DUS MC MR US 0 QUS = 2, 000 4, 500 Q US, Units per year

Profit maximising multimarket equilibrium

Efficiency of multimarket equilibrium (b) United States p, $ per unit (a) Japan 4, 500 3, 500 CSUS p. US = 2, 500 CSJ p. J = 2, 000 DJ πUS πJ DWLUS MC 500 Source: Perloff QJ = 3, 000 7, 000 QJ , Units per year MC 500 MRJ 0 DUS MRUS 0 QUS = 2, 000 4, 500 QUS, Units per year

Efficiency of multimarket equilibrium • Compared with competition, multimarket equilibrium is inefficient. • Compared with a single price monopolist it the effect on efficiency is unclear. – Deadweight loss is likely to be reduced because we move closer to perfect price discrimination. – A new source of inefficiency is introduced. Consumers waste time looking for the best deal and the opportunity to trade with one another.

Two part tariff • To purchase a good consumers pay: – A fixed fee – A fee which varies with the amount consumed • Telephone companies, Newcastle United season tickets. • Principle: – Set price to maximise consumer surplus. – Charge an amount equal to the consumer surplus to participate.

Two part tariff with identical consumers p, $ per unit 80 D 1 A 1 = $1, 800 20 10 0 Source: Perloff B 1 = $600 C 1 = $50 m 60 70 80 q 1, Units per day

Two part tariff with different consumers (a) Consumer 1 (b) Consumer 2 p $ per unit , 100 p , $ per unit 80 D 2 D 1 A = $3, 200 2 A 1=$1, 800 20 10 0 Source: Perloff B 1= $600 C =$50 1 m 607080 q 1, Units per day 20 10 0 C 2=$50 B 2=$800 m 8090100 q 2, Units per day

Tie in sales • Customers buying a product are required to make subsequent purchases of a related product from the same firm. – Car parts – Printer cartridges • Producer surplus increases at the expense of consumers. • Efficiency probably increases because transaction costs are lowered.

Bundling • Firms selling two or more goods can charge a price for a combination of goods. – Meal deals. • Bundling is profitable if willingness to pay for goods is negatively correlated across consumers. – Consumers who are prepared to pay a high price for a burger have a low willingness-to-pay for the drink.