Price discrimination IB Economics

Objectives Explain the meaning of price discrimination Identify the conditions for PD to occur Give examples of PD What effects will it have on welfare & efficiency Evaluate who benefits and who loses from PD

Conditions for Price discrimination 1.The firm must have some price setting power. (So PC is a no-no for this!) 2.Different (& Identifiable) groups of consumers with different PEDs 3.The firm must be able to stop seepage from one market to another.

Pricing in a Monopoly LRAC = LRMC Monopoly Demand (AR) MR Q1 Revenue Cost and Profit Output (Q) D E Qc B A C

Pricing decisions under PD Quantity of Output (Q) Price (P) AR (Market Demand) MR P1 AC = MC Q1 P2 P4 Q3 Q2 Equilibrium output with perfect price discrimination – the monopolist will sell an extra unit providing that the next unit adds as much to revenue as it does to cost P3 P5 Q4Q5

Reason number 1: Excess capacity Seller shave spare capacity that they would rather get something for rather than nothing… E.g. Cheaper restaurant meals at lunchtimes Cheaper car rentals at weekends Cheaper hotels off-peak

How does this work? If we assume that the MC is constant, and There are two demand curves a peak one which is price inelastic and an off-peak one which is more price elastic, and Demand will peak at predictable times, then…

How? Then by raising prices to the peak demand and taking advantage of their willingness to pay the firm appropriates some of that consumer surplus for itself. The supplier will often cut prices at other times to use up some of that spare capacity and so increase TR Is there a pattern that makes this more likely in some industries than in others?

Peak and off peak pricing Supply (Marginal Cost) Off-Peak Demand Peak Demand MR Off-Peak MR Peak Price Off-Peak Price Peak Output Off-PeakOutput Peak Price (P) and Costs Output

Alternatively… Monopolist seeks to max profit in each market. Increase sale sin market A by lowering price Reduce sales in market B by raising price Which is elastic and which inelastic? E.g. Drugs companies selling aids drugs in Africa Gender pricing in bars Student/old people discounts

Diagrammatically Market AMarket B MC=AC Quantity Price Pa Pb MRa MRbARb ARa Profit from selling to market A – with a relatively elastic demand – and charging a lower price Demand in segment B of the market is relatively inelastic. A higher unit price is charged MC=AC Qb Qa

There are some advantages to this Some consumers are bought into the market who would otherwise not have afforded it. Higher output than under a single price monopoly Profits may finance further RnD Profits may cross-subsidise other activities BUT THE MAIN AIM IS RAISE REVENUES AND PROFITS!

In Practice Do firms really know the shape and location of their cost curves? What will other suppliers in the market do? (Oligopoly) Not all differences in price are to do with different groups having different P.E.D.s!

Product differentiation Price differences often reflect product differences They may reflect the cost of supplying different groups E.g. difference between business and cattle class on a plane. There is some PD, but the products are different.