3. Screening
Amine Ouazad
Microeconomics C
Career Choices
• A real estate broker wishes to hire an agent.
He posts a job offer.
• Initially, the dealer was offering 50,000 euros
a year, fixed. What was/were the problem?
• The compensation is as follows:
– The salesman gets 1% of all sales, and an
additional fixed wage of 30,000 euros.
– The average price of a house in the area is
150,000 euros.
• Who accepts the offer?
Push a little further
• What is the optimal contract?
• The real estate broker is greedy:
max Revenue – Wage.
• The productive candidate has options:
Wage >= productive broker’s outside option.
• The unproductive candidate has (worse) options:
Wage >= unproductive broker’s outside option.
• What is the optimal wage contract, assuming it is
a fixed percentage + a flat wage?
Outline
1. Asymmetric information on the labor market
(done)
2. Screening car rental customers:
Explicit price discrimination
3. Screening airline customers:
Implicit price discrimination
4. Screening eclectic and obsessive customers:
Bundling
P
P
High
valuation
customers
Lower valuation
customers
Optimal
price
MC
MC
Variable profit
“No money is
left on the
table”
Variable
profit
Demand
Demand
Q
Q
MR
Uniform Pricing
Perfect Price Discrimination
“A key step is to avoid uniform pricing. Pricing to specific
customer groups should reflect the true competitive
value of what is being provided. No money is left on the
table...”
A. Miles, Pricing, Boston Consulting Group.
Spot the Difference
2. Explicit Price Discrimination
Segment the market by observable characteristics.
Charge customers in different segments different prices,
according to their elasticity.
Condition #1: Market Power
• Must have ability to set prices
Condition #2: Observability (No deception)
• Use an easily observed trait which is correlated with elasticity of
demand.
• Customer cannot masquerade as someone else.
Condition #3: No arbitrage/resale
• Customers from one segment cannot sell good to others.
Explicit Price Discrimination
- Condition #2: Observability
• Tourists pay more for kilims in Istanbul than locals.
• Students get discounts on air/rail tickets.
• Californians pay $97; non-Californians pay $151 for a 2-day park
hopper
• Dell Inspiron 580, Base Configuration: Home:$749 Small Business:
$899
• Victoria’s secret?
Condition #3: No Arbitrage
Railroad freight pricing
U.S. railroads charge 1.5-2 times as much
to move coal as they do to move grain
per ton;
90
Coal
PC = 90 - 10 QC
MC = $10
Grain
PG= 60 - 5 QG
60
PC
MC
10
MRC
MRC = 90-20QC = 10 = MC
QC = 4
PC = $50
PG
MRG
MRG = 60-10QG = 10 = MC
QG=5; PG = $35
Higher choke price → Less Elastic → Higher price
Outline
1. Asymmetric information on the labor market
2. Screening car rental customers:
Explicit price discrimination
3. Screening airline customers:
Implicit price discrimination
4. Screening eclectic and obsessive customers:
Bundling
2. Implicit Price Discrimination
The Mother of All Discriminatory Pricing: Airline Pricing
Airlines like to segment the market based on valuations, but
valuations are not observed
 On the other hand, valuations are correlated with time sensitivity
 In general consumers with higher valuation are less likely to accept:
• Saturday night stay
• A 14-day advance ticketing ,..etc.
 Solution: Create a product line based on artificial restrictions.
These simply annoy the customers, and have little or no
bearing on their cost of operation
Screening with Differentiated Products
Scenario: Airline has B business customers and L leisure customers.
Valuation
Type of
Customer
Unrestricted
Restricted
Business
$1000
$600
Leisure
$600
$500
Cost per ticket = $ 300
(Same for restricted and unrestricted tickets)
– Explicit Market Segmentation –
Pricing of Only Unrestricted Tickets
Option 1: Charge $1000 and sell only to Business travelers
Profit = (1000-300)*B = 700B
Option 2: Charge $600 and sell to both Business and Leisure
Profit = (600-300)*(B + L) = 300 (B + L)
Screening with Restricted & Unrestricted Tickets
Option 3: Charge $900 and sell unrestricted tickets to Business travelers
Charge $500 and sell restricted tickets to Leisure travelers
Profit = (900-300)*B + (500-300)L = 600B + 200L
This is Screening or Implicit Market Segmentation
Comparison of 3 Options
(A) sell only unrestricted tickets at a price of ___________ to business
travelers only;
Profit:
(B) sell only unrestricted tickets at a price of ____________ to all
travelers;
Profit:
(C) sell unrestricted tickets to business travelers for ____________ and
restricted tickets to leisure travelers for __________.
Profit:
Profit
60000
A
50000
C
40000
30000
B
20000
10000
% Bus. Travelers (B )
0
0
10
B Best
20
30
40
50
C Best
60
70
80
A Best
90
100
Wrap Up
• Even if you cannot explicitly segment the market
don’t lose heart – implicitly segment the market!
• Offer a menu of options and try to come up with a
creative screening mechanism
• Try product differentiation, versioning, intertemporal pricing, damaging, bundling (see this
next time) – these achieve price discrimination
Outline
1. Asymmetric information on the labor market
2. Screening car rental customers:
Explicit price discrimination
3. Screening airline customers:
Implicit price discrimination
4. Screening eclectic and obsessive customers:
Bundling
Bundling
• Selling several goods in one bundle
Hardware and software
Software suites
Sports/Concert tickets
Auto accessories
Exercise 6.6: Screening via Bundling
Pricing of a two-concert mini season (Wagner and Harbison) at a
theater.
Highly segmented, with only three types of customers:
Valuation
Type of
Customer
Wagner
Verdi
A
$50
$5
B
$40
$40
C
$5
$50
A customer may go to one or both of the concerts.
– Benchmark: Explicit Market Segmentation –
– No Bundling –
– Pure Bundling –
– Mixed Bundling –
The Genius of Dell??