Presentation on theme: "Chapter 11Slide 1 Price Discrimination: Capturing CS Quantity $/Q D MR P max MC If price is raised above P*, the firm will lose sales and reduce profit."— Presentation transcript:
Chapter 11Slide 1 Price Discrimination: Capturing CS Quantity $/Q D MR P max MC If price is raised above P*, the firm will lose sales and reduce profit. PCPC P C is the perfectly competitive price. A P* Q* P1P1 Between 0 and Q*, consumers will pay more than P*--consumer surplus (A). B P2P2 Beyond Q*, price will have to fall to get at consumer surplus (B). P*Q*: MC=MR A: CS with P* B: P>MC; consumer would buy at a lower price P 1 : less sales and π P 2 : increase sales; π
Chapter 11Slide 2 P* Q* Without price discrimination, output is Q* and price is P*. Variable profit is the area between the MC & MR (yellow). First-Degree (Perfect) Price Discrimination Quantity $/Q P max Each consumer pays their reservation (maximum) price: Profits Increase Consumer surplus is the area above P* and between 0 and Q* output. D = AR MR MC Output expands to Q** and price falls to P C where MC = MR = AR = D. Profits increase by the area above MC between old MR and D to output Q** (purple) Q** PCPC
Chapter 11Slide 3 First Degree Price Discrimination The model does demonstrate the potential profit (incentive) of using some degree of price discrimination. Examples of imperfect price discrimination where the seller has some ability to segregate the market and charge different prices for the same product: Lawyers, doctors, accountants Car salesperson (15% profit margin) Colleges and universities
Second-Degree Price Discrimination Quantity $/Q D MR MC AC P0P0 Q0Q0 Without discrimination: P = P 0 and Q = Q 0. With second-degree discrimination there are three prices P 1, P 2, and P 3. (e.g. electric utilities) P1P1 Q1Q1 1st Block P2P2 Q2Q2 P3P3 Q3Q3 2nd Block3rd Block Second-degree price discrimination is pricing according to quantity consumed--or in blocks.
Chapter 11Slide 5 Third Degree Price Discrimination 1) Divides the market into two-groups. 2)Each group has its own demand function. 3)Most common type of price discrimination. Examples: airlines, liquor, vegetables, discounts to students and senior citizens. 4) Feasible when the seller can separate his/her market into groups who have different price elasticities of demand (e.g. business air travelers versus vacation air travelers)
Chapter 11Slide 6 Third Degree Price Discrimination P 1 : price first group P 2 : price second group C(Q r ) = total cost of Q T = Q 1 + Q 2 Profit ( ) = P 1 Q 1 + P 2 Q 2 - C(Q r ) Pricing: Charge higher price to group with a low demand elasticity.
Chapter 11Slide 7 Third-Degree Price Discrimination Quantity D 2 = AR 2 MR 2 $/Q D 1 = AR 1 MR 1 Consumers are divided into two groups, with separate demand curves for each group. MR T MR T = MR 1 + MR 2
Chapter 11Slide 8 Third-Degree Price Discrimination Quantity D 2 = AR 2 MR 2 $/Q D 1 = AR 1 MR 1 MR T MC Q2Q2 P2P2 QTQT Q T : MC = MR T Group 1: P 1 Q 1 ; more inelastic Group 2: P 2 Q 2 ; more elastic MR 1 = MR 2 = MC MC depends on Q T Q1Q1 P1P1
Chapter 11Slide 9 The Economics of Coupons and Rebates Those consumers who are more price elastic will tend to use the coupon/rebate more often when they purchase the product than those consumers with a less elastic demand. Coupons and rebate programs allow firms to price discriminate. Price Discrimination
Chapter 11Slide 10 Airline Fares Differences in elasticities imply that some customers will pay a higher fare than others. Business travelers have few choices and their demand is less elastic. Casual travelers have choices and are more price sensitive. The airlines separate the market by setting various restrictions on the tickets. Less expensive: notice, stay over the weekend, no refund Most expensive: no restrictions
Chapter 11Slide 11 Intertemporal Price Discrimination Separating the Market With Time Initial release of a product, the demand is inelastic Book, Movie, Computer 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, Dollar Movies, Discount computers
Chapter 11Slide 12 Intertemporal Price Discrimination Quantity AC = MC $/Q Over time, demand becomes more elastic and price is reduced to appeal to the mass market. Q2Q2 MR 2 D 2 = AR 2 P2P2 D 1 = AR 1 MR 1 P1P1 Q1Q1 Consumers are divided into groups over time. Initially, demand is less elastic resulting in a price of P 1.
Chapter 11Slide 13 Demand for some products may peak at particular times. E.g. Rush hour traffic, Electricity - late summer afternoons, Ski resorts on weekends 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
Chapter 11Slide 14 MR 1 D 1 = AR 1 MC P1P1 Q1Q1 Peak-load price = P 1. Peak-Load Pricing Quantity $/Q MR 2 D 2 = AR 2 Off- load price = P 2. Q2Q2 P2P2
Chapter 11Slide 15 The Two-Part Tariff The purchase of some products and services can be separated into two decisions, and therefore, two prices. Examples: 1)Amusement Park: Pay to enter; Pay for rides and food within the park 2)Tennis Club: Pay to join; Pay to play 3)Rental of Mainframe Computers: Flat Fee; Processing Time 4)Safety Razor: Pay for razor; Pay for blades 5)Polaroid Film: Pay for the camera; Pay for the film
Chapter 11Slide 16 Usage price P* is set where MC = D. Entry price T* is equal to the entire consumer surplus. T* Two-Part Tariff with a Single Consumer Quantity $/Q MC P* D
Chapter 11Slide 17 D 2 = consumer 2 D 1 = consumer 1 Two-Part Tariff with Two Consumers Quantity $/Q MC A B C Q1Q1 Q2Q2 The price, P*, will be greater than MC. Set T* at the surplus value of D 2. T* P*
Chapter 11Slide 18 The Two-Part Tariff The Two-Part Tariff With Many Different Consumers No exact way to determine P* and T*. Must consider the trade-off between the entry fee T* and the use fee P*. Low entry fee: High sales and falling profit with lower price and more entrants. To find optimum combination, choose several combinations of P,T. Choose the combination that maximizes profit.