Price Discrimination A possible outcome in IMPERFECT COMPETITION

Price Discrimination We have assumed that firms under all market structures charge a single price for all units of output they sell – In the case of monopoly (and other types of imperfect competition) while price varies according to quantity of output sold (along the demand curve), once the firm decides what quantity of output to produce, all units of output are sold at the same price Yet, in the real world, firms often find that they can increase their profits by selling their product at different prices and this introduces the idea of price discrimination

Price Discrimination (continued) Price discrimination is the practice of charging a different price for the same product to different consumers when the price difference is not justified by differences in costs of production Instead, different prices are set by geography, age, gender, income level, time, etc. Any examples you can think of? – Electricity bill: lower prices after midnight – Phone bill: lower prices after midnight, calls to certain regions, different plans – Water bill: higher prices during summer – Airlines and hotels: higher prices during peak season or for business people – Cinemas: different prices to kids and seniors, time of the day – Restaurants: happy hour before 6 and after 11 pm – Publishers: charge different prices of the same book in different countries – Sushi restaurants: where there is not a menu

Some conditions and requirements to practice price discrimination The price discriminating firm must have some market power (the ability to control price and barriers to entry) It is not possible (or at least very difficult and costly) for any consumer to buy the good at the lower price and resell at the high price (e.g. case of old Japanese iPhones) Markets can be SEPARATED Different groups of customers characterized with different price elasticities of demand (PED) for the good

Modelling price discrimination (first degree) Each consumer pays exactly the price that he is willing to pay THE ART OF NEGOTIATION---HAGGLING ZRc ZRc

Non-price discriminating PRICE DISCRIMINATING P willing to pay TRMR TRMR Brian¥ 100 Cato¥ 90 Don¥ 85 Eva¥ 80 Fred¥ 75

Diagram of 1 st Degree Price discrimination Assume a constant MC schedule= ¥80 Price/costs MC Q D=AR

Diagram of 1 st Degree Price discrimination (final) Non-price disciminatingPrice discriminating

Second degree price discrimination - based on quantities of a good consumed Firms sell off packages or blocks of a product deemed to be surplus capacity at lower prices eg peak and off-peak pricing schemes Price tends to fall as the quantity bought increases Examples of this can be found in the hotel industry where spare rooms are sold on a last minute standby basis. In these types of industry, the fixed costs of production are high. At the same time the marginal or variable costs are low and predictable. If there are unsold rooms, it is in the hotel's best interest to offload spare capacity at a discount prices, providing that the extra revenue at least covers the marginal cost of each unit.

Second degree price discrimination (con) Consumer A – buys …. Unit at $8 Consumer B – buys 1 unit at $8 and …….units at $6 Consumer C- buys 1 unit at $8, 4 units at $6 and….. Units at $4  Firm’s TR from consumer C is…….. (compare if sold 7 units at $4 or 5 units at $6 if MR intersects MC at Q=5)  EVALUATION

Evaluation of second degree price discrimination  ……………………. Supplied than if non-price discriminating  Last consumer gets good where MB=MC  BUT  Firm removes some of consumer surplus  May encourage over- consumption (eg of water or electricity)

Modelling 3 rd degree price discrimination With small white-boards and side-by-side diagrams Assume firm faces two consumer groups for their product X, who have different PEDs. Assume constant marginal costs Draw on marginal revenue curves and then find profit-maximising price and quantity for each group

Modelling 3 rd degree price discrimination Assume firm faces two consumer groups for their product X, who have different PEDs. This is shown as follows (assume constant marginal costs)

Third degree price discrimination - based on the principle that different consumer groups have different price elasticities of demand (PED) for the product. This is the most common form of price discrimination As the consumers are separated into different groups based on the PED, firm charges higher prices to consumers with low PED and lower prices to those with higher PED – Business traveler's demand for air tickets is more inelastic and airline tickets are more expensive – Demand for phone services for businesses during the day are more inelastic, also charged at a higher rate – Demand for hotels and restaurants are more inelastic during holidays and weekends and thus are charged higher – Uniqlo charges higher prices for certain goods during the weekdays (inelastic, less time to shop) than during the weekends (elastic, more time to shop) – Demand for cinema or transport services by seniors is more elastic than adults thus charged a lower rate

The firm decides how much quantity to produce for each market by equating its MC (of total market) with the MR of each individual market which gives Q1 and Q2, sold at P1 and P2, respectively. As you can see: – A higher price (P1) is charged for consumer group with relatively inelastic demand and – A lower price (P2) is charged for consumer group with relatively elastic demand Remembering the relationship of PED, price, and total revenue, when a firm raises prices for consumers with low PED, Q does not decrease as much proportionately as the increase in P and total revenue increases. And if the firm lowers its prices for consumers with high PED, total revenue increases.  Thus, price discrimination leads to higher revenues and profits than if the firm sets one price and does not price discriminate.

Evaluation of price discrimination Total output with price discrimination may increase in comparison to the case when only single price is charged in a single market/demand If it increases, allocative inefficiency could improve Possibly increased monopoly power where firm uses price discrimination not only to maximize profit but also to create barriers to entry to drive out rival firms through setting low prices (predatory pricing) Ie. Use profit in one “market “ to undercut prices in market with more elastic demand = DUMPING (occurs if a firm sells a good in an overseas market at a lower price than the price charged in its own domestic market) Prices maybe lower for some groups and higher for other groups in comparison to the single price without price discrimination. Therefore some groups who were unable to afford the good previously (e.g. students, children, seniors, mid- week restaurant goers) will benefit with increase in consumer surplus. Vice versa for the other group who now pay a higher price  more or less equity? What happens to overall consumer surplus depends on what happens to output. If output increases, CS could increase or decrease depending on the price and the circumstances. Some consumers (who otherwise might not have bought the good at a single price) might gain surplus, others (who pay higher prices) will lose it