First thru Third Degree
Price Discrimination
First-Degree Price Discrimination
• Under first-degree price discrimination, each customer is charged the
highest price they are willing and able to pay.
• Example: Dutch auction
• The monopolist can capture the entire consumer surplus.
• Apple: IPod releases
• Initial high price
• Price lowered 6 months later
2
Simple Single Priced Monopolist
Monopolist sets only 1 price for all customers\
First chooses Q* such that MR(Q*) = MC(Q*) – here at Q1
Then sets price at max price consumer will pay for Q1 units – here P1
CS extracted by
Monopolist
9
Welfare with and without price discrimination
(a) Monopolist with Single Price
(b) Monopolist with Perfect Price Discrimination
Price
Price
Consumer
surplus
Deadweight
loss
Monopoly
price
Profit
Profit
Marginal
revenue
0
Marginal cost
Marginal cost
Quantity
sold
Demand
Demand
Quantity
0
Quantity
sold
Quantity
Panel (a) shows a monopolist that charges the same price to all customers. Total surplus in this market equals
the sum of profit (producer surplus) and consumer surplus. Panel (b) shows a monopolist that can perfectly
price discriminate. Because consumer surplus equals zero, total surplus now equals the firm’s profit.
Comparing these two panels, you can see that perfect price discrimination raises profit, raises total surplus,
and lowers consumer surplus.
4
First Degree Price Discrimination
Charge consumer Max price for each unit purchased
PPD Monopolist charges a different price for each unit sold to the consumer
Simple (single price) Monopolist and
Perfect Price Discrimination
All CS lost to PPD Monopoly
CS lost to simple monopoly
Restricting Quantity and Price Discrimination
Charge price = sum(WTP)/Qsold
Extract all CS
P-PC
TR
MR
10
10
9
18
8
MC
CS-PC
4
0
8
4
$1
3 only
24
6
4
$3
p=$9
CS= 0
7
28
4
4
$6 M-1P
6
30
2
4
$10
6 only
pay
5
30
0
4
$15
4
28
-2
4
$21 PC
3
24
-4
4
$28
2
18
-6
4
$36
1
10
-8
4
$45
7.5
WTP
45
CS = 0
$45
Third degree price discrimination
Charge different prices in different markets
Charge Max WTP for each customer
Major problem – need to prevent resale from customer with lower WTP to customer with higher WTP
Price Discrimination
• Lessons from perfect price discrimination
1. Rational strategy
• Increase profit
• Charges each customer a price closer to his or her willingness to pay
• Sell more than is possible with a single price
9
Price Discrimination
• Lessons from price discrimination
2. Requires the ability to separate customers according to their
willingness to pay
• Certain market forces can prevent firms from price discriminating
• Arbitrage – buy a good in one market, sell it in other market at a higher
price
3.
Can raise economic welfare
• Can eliminate the inefficiency of monopoly pricing
• More consumers get the good
• Higher producer surplus (higher profit)
10
Price Discrimination
• The analytics of price discrimination
• Perfect price discrimination
• Charge each customer a different price
• Exactly his or her willingness to pay
• Monopolist - gets the entire surplus (Profit)
• No deadweight loss
• Without price discrimination
•
•
•
•
11
Single price > MC
Consumer surplus
Producer surplus (Profit)
Deadweight loss
Second-Degree Price Discrimination
• Second-degree price discrimination occurs when firms sell their
product
at a discount when consumers buy large quantities.
• Example: Electricity prices?
• Costco/Sam’s Club – “Big Box Stores”
• http://www.amosweb.com/cgibin/awb_nav.pl?s=wpd&c=dsp&k=seconddegree+price+discrimination
12
Third-Degree Price Discrimination
• Under third-degree price discrimination,
a firm charges different prices in different markets for their product.
• The most common form of price discrimination
• Examples include:
•
•
•
•
Children's discounts
Senior citizen’s discounts
Airfares
Different geographic markets (Madison Park, U District)
13
To Be Able to Do Price Discrimination
• To be a successful price discriminator, a seller must satisfy three
conditions:
• (1) to have market control and be a price maker,
• (2) to identify two or more groups that are willing to pay different prices, and
• (3) to keep the buyers in one group from reselling the good to another group.
14
A Word from the FTC on Discriminatory Pricing
• A seller charging competing buyers different prices for the same "commodity" or
discriminating in the provision of "allowances" -- compensation for advertising
and other services -- may be violating the Robinson-Patman Act. This kind of price
discrimination may hurt competition by giving favored customers an edge in the
market that has nothing to do with the superior efficiency of those customers.
However, price discriminations generally are lawful, particularly if they reflect the
different costs of dealing with different buyers or result from a seller’s attempts
to meet a competitor’s prices or services.
15
A Word from the FTC on Discriminatory Pricing
• A seller charging competing buyers different prices for the same "commodity" or
discriminating in the provision of "allowances" -- compensation for advertising
and other services -- may be violating the Robinson-Patman Act. This kind of price
discrimination may hurt competition by giving favored customers an edge in the
market that has nothing to do with the superior efficiency of those customers.
However, price discriminations generally are lawful, particularly if they reflect the
different costs of dealing with different buyers or result from a seller’s attempts
to meet a competitor’s prices or services.
16
3 Major Pieces of Legislation to address AntiCompetitive Markets
• Sherman Anti-trust Act (1890)
• Anti-competitive behavior, mergers
• Clayton Act (1914)
• Price discrimination (simple)
• Tie-in sales
• Robinson-Putman (1936)
• More detailed/complex definition of price discrimination
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13-17
Sherman Anti-trust Act
• As explained by the U.S. Supreme Court in Spectrum Sports, Inc. v.
McQuillan,
• “ The purpose of the [Sherman] Act is not to protect businesses from the
working of the market; it is to protect the public from the failure of the
market. The law directs itself not against conduct which is competitive, even
severely so, but against conduct which unfairly tends to destroy competition
itself
• The law attempts to prevent the artificial raising of prices by restriction of
trade or supply.[4]
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13-18
Sherman Anti-Trust Act
• Divided into three sections.
• Sec 1 delineates and prohibits specific means of anticompetitive conduct,
(e.g., contracts/agreements)
• Sec 2 deals with end results that are anticompetitive in nature. (actual pricing
tactics, or non-compete)
• Sec 3 simply extends the provisions of Section 1 to U.S. territories and the
District of Columbia.
Copyright © 2006 Pearson Addison-Wesley. All rights reserved.
13-19