Price Discrimination Module KRUGMAN'S MICROECONOMICS for AP* 27 63 Margaret Ray and David Anderson

What you will learn in this Module: What is price discrimination? What is the relationship between price discrimination and consumer/producer surplus? The purpose of this module is to show that, when compared to perfect competition, the existence of monopoly reduces output and raises prices to consumers, while earning economic profit for the firm. By producing at an output below that where P=MC, monopoly causes a loss of total welfare: deadweight loss. In order to mitigate the negative consequences for consumers, government can adopt policies to regulate a monopoly firm.

What is Price Discrimination? Charging different price to different consumers for the same product. So far we have looked at a monopolist who charges only one price Pm to all customers buying Qm units. This is called a single-price monopolist. So far we have looked at a monopolist who charges only one price Pm to all customers buying Qm units. This is called a single-price monopolist. Price discrimination occurs when the same product is sold to different consumers at different prices. The definition of the product can complicate this simple definition. For example, is an airline flight on Saturday the same product as an airline flight during the week? Is a left-handed golf club the same as a right-handed golf club? While the definition is simple in theory, it becomes difficult in practice. Firms engage in price discrimination to raise their profits.

Price Discrimination A restaurant in a university town has a special small meal popular with elderly people and poor university students. Assume that: 1) Restaurants’s MC=$2 2) There are 100 seniors willing to pay $4. 3) There are 100 college students willing to pay $8.  A single-price firm might face a tough choice on what price to charge. 1. Lenny’s could set the price at $8 and sell only to the college students, but lose the senior citizens. Total Profit = 100*($8 - $2) = $600   2. Lenny’s could set the price at $4 and sell to both groups, but lose substantial profit to the college student segment of the market. Total Profit = 200*($4 - $2) = $400 Or Lenny’s could try to differentiate between the two groups (by asking seniors to show valid ID) and offer two different prices to customers. College students will pay $8 and seniors will pay $4 for a Slam Grand breakfast. Total profit = 100*($8 - $2) + 100*($4 - $2) = $800

Elasticity and Price Discrimination Why are some consumers not as willing or able to pay for a product? Hint: It has to do with differences in price elasticity of demand. Why would one group of consumers willingly pay a high price for a product, while a second group of consumers is willing to pay a much lower price for the same product? The first group has a lower price elasticity of demand.  

Elasticity and Price Discrimination What might make one group unwilling to pay a higher price? Some examples: more Flexibility A smaller budget Different preferences more Substitutes  What might make one group unwilling to pay a higher price? Some examples: Different preferences A smaller budget More flexibility More substitutes

Perfect Price Discrimination Perfect price discrimination: each consumer is charged exactly his/her maximum willingness to pay. With perfect price discrimination price is equal to willingness to pay for each consumer. The entire area below the demand curve and above the MC curve is profit to the monopolist. Perfect price discrimination insures that consumer surplus is equal to zero.   Also, because the last unit is sold where P=MC, there exists no deadweight loss under this pricing strategy.

Perfect Price Discrimination How big is the consumer surplus? What happened to deadweight loss?

How? Advanced purchase restrictions Volume discounts Two part tariffs – “club cards”