The practice of charging unequal prices or fees to different buyers (or classes of buyers) is called price discrimination

Examples of price discrimination Physicians charge more for an office visit if the patient has health insurance. Magazines such as Sports Illustrated offer gifts and discounts to new subscribers. Senior citizens may enjoy discounted rates at motels and restaurants. Cinemas charge higher ticket prices for adults than for kids. Japanese steel and Canadian timber producers earn sharply lower profit margins on products sold in the U.S. compared to the domestic market.

“Sizing up their income” pricing by plumbers, auto mechanics,... A Mercedes driver can pay more, so why not charge them more?

When is price discrimination feasible? Price-discrimination (PD) can be a very lucrative proposition from the seller’s point of view. However, PD will not be feasible or possible unless: 1.The seller possesses market power—meaning, the seller faces a downward sloping demand curve. 2.The seller is capable of segregating buyers into groups based on differential willingness to pay, or elasticity of demand (  ). Hear audio explanation (wav).audio explanation 3.The seller can prevent arbitrage or resale of the product. Her audio explanation (wav)audio explanation

This is referred to as “perfect” PD. The seller charges every buyer their “reservation price”—that is, the maximum price they are willing to pay rather then go without the marginal unit of the good or service

Quantity A PCPC Price 0 MC D MR QMQM QCQC Notes Perfectly discriminating monopolist charges P C for the last unit only. Market output is equal to the competitive output (Q C ) Total Surplus (TS) is equal to green shaded area AP C B Hear audio explanation (wav)audio explanation B

3 rd degree price discrimination: the welfare effects To illustrate these effects we use the example of Kevlar, du Pont’s patented, super- strength synthetic fiber. We assume there are two uses for Kevlar 1.Undersea cables 2.Tires

Differential elasticities of demand (  ) Steel and fiberglass are good substitutes for Kevlar in tire production; where there are no good substitutes for Kevlar in the manufacture of undersea cable. Let  t denote the elasticity of demand for Kevlar on the part of tire makers.  c is the elasticity of demand for Kevlar for use in production of undersea cables. Thus:  t >  C [1]

Symbols, assumptions Let: P c : Price per unit of Kevlar charged to cable manufactures; P t : Price per unit of Kevlar charged to tire manufacturers; q c : Quantity of Kevlar purchased by cable manufacturers; q t : Quantity of Kevlar purchased by tire manufacturers. We assume that MC = ATC = $20. The demand functions are given by: q C = Pc q t = 60 - Pt

D tires MR t N H CJ MC 4060 Cable Tires D cable D cable + tires MR C MR C + t Price 50 W AS F Price discriminating firm sets MR = MC in each “sub”market Audio explanation Audio explanation (wav)

2 scenarios Standard monopoly pricing (single price) P C = P t = $50 Q = q C + q t = = 60 units  = TR – TC = [(50)(60)] – [(60)(20)] = $1,800 3 rd degree price discrimination P C = $60; P t = $40 audio explanation (wav)audio explanation Q = q C + q t = = 60 Units  = TR – TC = {[(60)(40)] +[(40)(20)]} – [(60)(20)] = $2,000

So, du Pont can increase its profits by $200 (from $1,800 to $2,000) by practicing price discrimination

As a consequence of P.D., cable manufacturers pay $60 per unit instead of $50. This gives rise to a welfare loss of WFSA or $350.WFSA If du Pont discriminates, then tire manufacturers pay a lower price than they otherwise would ($40 instead of $50). This gives rise to a welfare gain of NHGJ or $250.NHGJ Thus,  TS = WFSA + NHGJ = -$250

By enforcing statutes applicable to price discrimination (specifically, section 2 of the Clayton Act), the total surplus could be potentially increased by $250.section 2 of the Clayton Act