The Theory of the Firm Price Discrimination Definition Conditions 1st/2nd/3rd Degrees

Have you ever paid a different price than someone else for the same good (or service)?

“introduction to price discrimination” By Marginal Revolution University (9:40): https://www.youtube.com/watch?v=SZCV-Gm0Tf4  “introduction to price discrimination” Practice Qs on vid can be found here: http://www.mruniversity.com/node/301739?utm_source=PrinciplesAnnot&utm_medium=PQAnnot&utm_campaign=MRUYTAnnotation

Price discrimination definition “The practice of charging different prices to different consumer groups for the same product, where the price difference is not justified by differences in cost." Price discrimination definition

Why discriminate? Profit maximization!

Conditions for price discrimination (All 3 MUST exist!) 1. Firm must possess some degree of market power 2. Must have consumers w/differing PEDs for same product 3. Firm must be able to separate groups to ensure that no resale of the product occurs

If the first 2 conditions existed but not the 3rd, what should happen? Firm sell less but @ price in the middle. (Where MC = MR). Low-paying consumers will not receive benefit of good/service. (See upcoming slides)

Is price discrimination beneficial for society? If it increases output, (usually) YES If it does not increase output, (usually) NO

Other consumer benefits: Perfect price discrimination always reduces CS. 3rd degree doesn’t necessarily if some consumers still pay less than they were willing to pay (rich person still might fly on Tuesday). If output improves, allocative efficiency increases. Problems: Firms may increase monopoly power, possibility of dumping, Positives: Should lead to more economies of scale which could reduce price for various segments. Allows lower income Other consumer benefits: Increased R & D, more availability/consumers purchasing Negatives for consumers: Often decreases consumer surplus (Remember definition?) Why?!

Types of Price Discrimination 3rd degree: By consumer group age, income, gender, time of purchase (day of week, time of day, week of purchase), etc. a.k.a. “market segmentation” Restaurants, hotels, airlines, cinemas, Uber, etc. (only need to graph 3rd degree for IB) (Remember: Each group has a different PED!) 2nd degree: By quantity Bulk buying (lower price/unit when more is purchased) 1st degree: By individual consumer “perfect price discrimination” Charges each consumer maximum price they are willing to pay No CS (consumer surplus). WHY??? AR = MR curve

EXTRA: DON’T NEED TO KNOW 4TH & 5TH, BUT INTERESTING NONETHELESS http://www.slideshare.net/joji14/price-discrimination-in-airline-industry-21261290

EXTRA: DON’T NEED TO KNOW GRAPHING 1ST DEGREE, BUT INTERESTING NONETHELESS Producers would gain CS & DWL, Consumers would lose CS, but social welfare would be maximized

Graphing 3rd Degree Price Discrimination Market A Market B Total Market (A + B) 3rd diagram is the aggregate market Diagrams 1 & 2: MC & AC is same (horizontal). Why? Costs same amount to produce each good (or service) ***Note: You don’t actually need to draw ARm on 3rd diagram***

3rd Degree Price Discrimination Diagrams (Tragakes) What price do markets 1 & 2 charge? Why? What is the MC for Markets 1 & 2? What is the AC for Markets 1 & 2? What is the TR & TC for Market 1? Does this firm experience normal profit? Why/Why not? Do you ever need to draw AFC or AVC? When does the MR curve start to “kink” for the aggregate market? What is the Aggregate Q? What is the Aggregate P? (trick question alert!) What is the TR for the market? What price do markets 1 & 2 charge? Why? P1 & P2 b/c MC = MR What is the MC for Markets 1 & 2? Equilibrium point What is the AC for Markets 1 & 2? Equilibrium point What is the TR & TC for Market 1? P1 X Q1 = revenue. Pequilibrium X Q1 = cost Does this firm experience normal profit? Why/Why not? Abnormal b/c TR > TC Do you ever need to draw AFC or AVC? No When does the MR curve start to “kink” for the aggregate market? After P from inelastic market What is the Aggregate Q? Q3 What is the Aggregate P? Depends on the individual market…not one true AR (trick question alert!). TR for the market = sum of TR for market 1 & market 2. Can’t figure it out just by looking @ 3rd di

3rd Degree Price Discrimination Diagrams (Tragakes) Reminder: D = AR Which market (1 or 2) should be the diagram for train travelers at peak times (instead of off peak times)? #1!

3rd Degree Price Discrimination Diagrams (Tragakes) Reminder: D = AR Recap: Why is the price higher for Market 1? Remember: determinants of elasticity!

Review & Extension

Review: Can you clearly explain the difference between each of these types of price discrimination? (w/o referring to notes!)

2. Are these all examples of price discrimination?? 1. Identify the type of price discrimination that may be evident in each situation. 2. Are these all examples of price discrimination?? Source: http://beta.tutor2u.net/economics/blog/unit-3-micro-examples-of-price-discrimination-in-action

Is this price discrimination? Justify your answer.

4. Should senior citizens be entitled to a discount?? Source: http://beta.tutor2u.net/economics/blog/putting-the-discrimination-into-price-discrimination 4. Should senior citizens be entitled to a discount??

5. What has happened in this situation? Do you think this happens often in the real world? (even if not so explicit) Is it price discrimination? Source: http://theincidentaleconomist.com/wordpress/price-discrimination/

Muay Thai Pricing

6. Explain how this quote could be true with price discrimination.

7. What type of price discrimination is evident in this graph? 3rd degree Source: https://www0.gsb.columbia.edu/faculty/gheal/B7006-001/pricing/sld043.htm

8. Explain why/how airlines practice price discrimination for the same type of seats on the same plane to the same destination? Source: http://mediagallery.usatoday.com/airlines

9. Would a firm ever be able to practice perfect price discrimination? a Maximum Auctions, lawyers, used car salesmen trying to figure out your price level 9. Would a firm ever be able to practice perfect price discrimination? Think of some possible products/circumstances.

10. What are main messages/ideas below? Source: http://bostinno.streetwise.co/channels/5-tips-to-save-money-using-online-privacy-tools/

11. Why do you think Australians were paying more for these items? What is geo-blocking? Source: http://visual.ly/choice-australia-how-does-price-discrimination-work

Final Qs before practicing What could the societal benefit be of a lawyer or a university charging different prices for the same service? Are taxes a form of price discrimination? TOK extension: How does one know the value of something?

Diagram & explain 3rd degree price discrimination Now…time to practice! Diagram & explain 3rd degree price discrimination

Can you still answer these? What price do markets 1 & 2 charge? Why? What is the MC for Markets 1 & 2? What is the AC for Markets 1 & 2? What is the TR & TC for Market 1? Does this firm experience normal profit? Why/Why not? Do you ever need to draw AFC or AVC? When does the MR curve start to “kink” for the aggregate market? What is the Aggregate Q? What is the Aggregate P? (trick question alert!) What is the TR for the market? What price do markets 1 & 2 charge? Why? P1 & P2 b/c MC = MR What is the MC for Markets 1 & 2? Equilibrium point What is the AC for Markets 1 & 2? Equilibrium point What is the TR & TC for Market 1? P1 X Q1 = revenue. Pequilibrium X Q1 = cost Does this firm experience normal profit? Why/Why not? Abnormal b/c TR > TC Do you ever need to draw AFC or AVC? No When does the MR curve start to “kink” for the aggregate market? After P from inelastic market What is the Aggregate Q? Q3 What is the Aggregate P? Depends on the individual market…not one true AR (trick question alert!). TR for the market = sum of TR for market 1 & market 2. Can’t figure it out just by looking @ 3rd di