1. Pricing Policies chapter 18
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2. Learning Objectives
Define price discrimination and the conditions necessary for price discrimination to be successful.
Identify various ways that a firm can price discriminate.
Describe the outcome of perfect price discrimination and its welfare effects.
Identify a monopolist’s profit-maximizing prices when it can discriminate based on observable customer characteristics and calculate the welfare effects of that discrimination.
Understand how pricing based on self-selection can increase a firm’s profit.
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3. Overview
Identify the conditions required for successful price discrimination, and discuss different ways that a firm can price discriminate
Study the firm’s profit-maximizing pricing strategy and consider the consequences for consumer and aggregate welfare
Observe how self-selection can increase a firm’s profit
Consider the practice of selling goods together as a bundle
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4. Price Discrimination
Price discrimination: when a firm charges different prices for different units of the same good
In order to price discriminate a firm must have some market power
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5. Perfect Price Discrimination
A monopolist can engage in perfect price discrimination if he knows a customer’s willingness to pay for each unit he sells, and can charge a different price for each unit
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6. Two-Part Tariffs
Two-part tariff: consumers pay a fixed fee if they buy anything at all, plus a separate per-unit price for each unit they buy
With a per-unit price of $1.50, the demand will be for 3 units. This leaves a consumer surplus of $2.25 (light-green triangle), so they would be willing to pay a weekly fee of $2.25, and no more
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7. Profit with a Two-Part Tariff and Identical Consumers
By lowering its per-minute charge from 20 to 10 cents, equal to its marginal cost, and raising its fixed fee, the firm can increase its profit to the maximum possible
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8. Observable Customer Characteristics
Observable customer characteristics: when a firm can distinguish, even if imperfectly, consumers with a high versus low willingness to pay
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9. Profit-Maximizing Prices to Two Groups of Consumers
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10. Profit-Maximizing Price without Discrimination
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11. Welfare Effects of Imperfect Price Discrimination
Price discrimination has two main effects on aggregate surplus
Different consumers pay different prices. As a result, a consumer with a low willingness to pay but facing a low price may decide to buy the good while a consumer with a higher willingness to pay may decide to not buy the good when faced with a higher price, resulting in inefficiency
Price discrimination may encourage the monopolist to sell more tickets
The two opposing effects can combine to either raise or lower aggregate surplus
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12. Changes in Consumer Welfare with Price Discrimination
Adults lose $1,600
Students gain $400
Decrease in consumer surplus = $1,200
Increase in profit = $800
=> Decrease in aggregate surplus
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13. Price Discrimination Can Increase Consumer and Aggregate Surplus
Without price discrimination a monopolist will abandon selling to low-demand consumers
Price discrimination in some cases will lead to more goods sold, making both aggregate and consumer surplus higher
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14. Price Discrimination Based on Self-Selection
Self-selection: when the firm offers a menu of alternatives, designed so that different customers will make different choices based on their willingness to pay
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15. Quantity-Dependent Pricing
Quantity-dependent pricing: the price a consumer pays for an additional unit depends on how many units the consumer has bought
$8 = fixed fee = PS for DH consumer
$8 = fixed fee = producer surplus for DL consumer
$32.50 = consumer surplus for DH consumer
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16. Using Menus to Increase Profit
Can increase profit from the two-part tariff if:
Deadweight loss could be eliminated
More could be extracted from the surplus of high-demand consumers
Accomplished by offering consumers a choice from a pair of two-part tariffs, with each tariff plan designed to attract a specific type of consumer
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17. Menu of Two-Part Tariffs
Producer surplus = $7.50
Producer surplus = $12.50
$4.50 = fixed fee
$4.50 = fixed fee
$8 = variable profit
$3 = variable profit
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18. Eliminating the Deadweight Loss of High-Demand Consumers
Offer a pair of two-part tariffs: one designed for low-demand consumers and the other for high-demand consumers
Set a per-unit charge for high-demand consumers equal to its marginal cost. The fixed fee must be set as large as possible without causing the high demand consumer to choose the other two part tariff instead
Eliminates deadweight loss for high-demand consumers
Extracts extra surplus through the plan’s fixed fee, earning a greater profit
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19. Making the Low-Demand Plan Less Attractive to High-Demand Consumers
Making the low-demand plan less a attractive to high-demand consumers increases profit
The option to choose the plan intended for low-demand consumers determines the fixed fee that one can charge a high-demand consumer
If the surplus a high-demand consumer has for the low-demand plan is reduced, the fixed fee for the high-demand plan can be increased
This is done by limiting the number of minutes a consumer can purchase the low-demand plan to the number that low-demand consumers want
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20. Capping Minutes In the Low-Demand Plan
Producer surplus = $40.50
Producer surplus = $7.50
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21. Bundling Bundling: selling several products together as a package
Technologically efficient
Increase a firm’s ability to extract consumer surplus, particularly when the WTP of the bundled products are negatively correlated
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22. Mixed Bundling
Mixed bundling: selling several products together as a package while also offering those products for sale individually
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23. Review
Under certain conditions, a firm with market power can increase its profit by charging different amounts for different units of the same good
A monopolist can perfectly price discriminate when he knows a customer’s willingness to pay for every unit he sells
When a monopolist cannot distinguish among different groups it may be able to price discriminate by offering each customer a menu of alternatives
Bundling can be a profitable strategy when the WTPs for each bundled product are negatively correlated
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24. Looking Forward
Next we will focus on another type of market—oligopoly—where firms still have market power, though not as much as a monopolist
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