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CHAPTER
DYNAMIC P OWERP OINT™ S LIDES BY S OLINA L INDAHL
Price Discrimination
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CHAPTER OUTLINE
Price Discrimination
Price Discrimination Is Common
Is Price Discrimination Bad?
Tying and Bundling
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questions
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Video
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Food for Thought….
Some good blogs and other sites to get the juices flowing:
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SEE THE INVISIBLE HAND
¿Qué Pasa?
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Price Discrimination
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Is it right for consumers to face
different prices based on their
age?
a) Yes
b) No
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A New York politician has suggested making gasoline
“Zone Pricing” (price discrimination) illegal. (1 minute)
http://www.dailymotion.com/video/xi6rlu_gas-price-discrimination_news
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Price Discrimination
Price Discrimination = selling the same
product at different prices to different
customers.
Why? To increase profit.
Profit will be greater with price discrimination
than without.
more
$$$
$ student
discount
normal price
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SEE THE INVISIBLE HAND
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Try it!
Who probably has more elastic demand for a Hertz
rental car: Someone who reserves a car online weeks
before a trip, or someone who walks up to a Hertz
counter after he walks off an airplane after a 4-hour
flight? Who probably gets charged more?
a) The person at the counter has a more elastic
demand and will be charged less.
b) The person at the counter has a more elastic
demand and will be charged more.
c) The person who booked in advance has a more
elastic demand and will be charged more.
d) The person who booked in advance has a more
elastic demand and will be charged less.
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Price Discrimination and
Profit Maximization
Recall the profit-maximizing rule for firms
with Monopoly power:
produce the Quantity where MR = MC
based on that Quantity, charge as much as
the market will bear (found by the position of
the demand curve)
But what if you sell to more than one
market, each with its own demand curve?
E.g. senior citizens and young people,
business travelers and leisure travelers.
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SEE THE INVISIBLE HAND
Can you spot who is willing to pay the most for an airplane ticket?
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SEE THE INVISIBLE HAND
Do you expect prices to be higher or lower near
the pirate dens in Somalia?
Pirates pay $5 for a shoeshine,
everyone else $.50. Full article
here
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Why Profits Increase with
Price Discrimination
Consider two demand curves- AIDs drugs in Africa and
Europe
Setting a single “world price” (assume the average of the
two markets) will necessarily reduce profits.
Price
Price
Europe
Africa
PEurope
PWorld
PWorld
PAfrica
Profit
MC=AC
MR
QEurope
D
Q
Profit
MC=AC
MR
QAfrica
D
Q
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The Principles of Price Discrimination
1a. If the demand curves are different, it is more
profitable to set different prices in different
markets than a single price that covers all
markets. (e.g. the firm wants to set different prices)
1b. To maximize profits the monopolist should set a
higher price in markets with more inelastic
demand.
2. Arbitrage makes it difficult for a firm to set
different prices in different markets, thereby
reducing the profit from price discrimination. (e.g.
the firm may not be able to set different prices)
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What price should the monopolist charge in Market A?
a)
$5
b)
$10
c)
$7
d)
Any price higher than $10
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A dry cleaner has a sign in its window: “Free internet
coupons.” The dry cleaner lists its website, and indeed
there are good discounts available with the coupons.
Most customers don't use the coupons. What is
probably the main difference between customers who
use the coupons and those who don’t?
a) Coupon users have elastic demand and non-users
have inelastic demand.
b) Coupon users have inelastic demand and nonusers have elastic demand.
c) Coupon users have perfectly inelastic demand
and non-users have perfectly elastic demand.
d) Coupon users have a higher value of their own
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time than the non-users use the coupons.
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Arbitrage
Arbitrage is taking advantage of
price differences for the same good
in different markets by buying low in
one market and selling high in
another market.
E.g. smuggling cheap AIDs drugs out of
Africa for resale in Europe
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Arbitrage makes it easier for a
firm to set different prices in
different markets.
a) True
b) False
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SEE THE INVISIBLE HAND
Think of a good someone should invent.
How would you price discriminate?
How would you prevent arbitrage?
Preventing Arbitrage
Firms develop arbitrage-discouraging
techniques
Red AIDs pills in Africa, White in Europe
Injecting arsenic into cheap industrial plastics to
prevent it from being pirated into the denture
industry (proposed but not practiced!)
Poisoning ethanol to keep it from being converted
to drinkable alcohol
Coding DVDs so cheaper Indian DVDs won’t play in
US players.
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Perfect Price Discrimination
PPD = each customer is charged his or her
maximum willingness to pay.
Since each consumer pays his or her
maximum willingness to pay under PPD,
consumers end up with no consumer surplus.
All of the gains from trade flow to the monopolist.
With this pricing strategy, the monopolist
produces until P = MC.
This level of output equals that of competition.
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PPD and Consumer Surplus
A Perfect Price Discriminator Marches Down the Demand Curve
Charging Each Customer Their Maximum Willingness to Pay
Price
Alex’s willingness to pay
Tyler’s willingness to pay
Robin’s willingness to pay
Marginal Revenue with
PPD
Bryan’s willingness to pay
MC
D
Qx
Quantity
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Perfect price discrimination
causes the marginal revenue
curve to equal the demand
curve.
a) True
b) False
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PPD in Practice
In practice PPD is difficult to implement: it
requires very detailed information on
consumers’ maximum willingness to pay.
Still, producers go to great lengths to gather
information on their consumers
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Is Price Discrimination Bad?
If price discrimination increases output,
then total surplus will increase.
This greater output reduces the deadweight
loss of monopoly.
If the firm practices PPD, then the
deadweight loss of monopoly is eliminated.
Price discrimination makes it easier for firms
to cover the fixed costs- increasing the
incentives to innovate.
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Tying and Bundling
Tying = a form of price discrimination in
which one good, called the base good, is
tied to a second good called the variable
good.
Firms are not just selling individual goods but
rather a package good.
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Tying
Tying allows firms to price discriminate.
Firms price discriminate by pricing the base
good below cost and the variable good above
cost.
Consumers reveal their willingness to pay
through the variable good.
Firms basically charge a different price to every
consumer based on their usage of the variable
good.
Printing a lot? You have a higher willingness to
pay-- and will pay more in ink costs.
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Bundling
Bundling = requiring products be
purchased together in a bundle or
package.
Firms use bundling when they have more
information on the demand for the bundle
than for the individual parts.
Bundling may help prevent arbitrage.
A Bundle of Chapters?
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Bundling in Action
Maximum Willingness to Pay for Word and Excel
Amanda
Yvonne
Word
$100
$40
Excel
$20
$90
If Microsoft sets prices individually, it can earn greater profits
by pricing Word at $100 and Excel at $90 (assuming
marginal cost of zero).
–At a price of $40, both Amanda and Yvonne will purchase Word
and profits will be $80.
–At a price of $100, only Amanda will purchase Word and profits will
be $100.
–At a price of $20, both Amanda and Yvonne will purchase Excel
and profits will be $40.
–At a price of $90, only Yvonne will purchase Excel and profits will be
$90.
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Bundling in Action
Maximum Willingness to Pay for Word and Excel
Amanda
Yvonne
Word
$100
$40
Excel
$20
$90
Office
$120
$130
If Microsoft bundles Word and Excel, the profit maximizing
price is $120 (assuming marginal cost of zero).
At a price of $130, only Amanda will purchase Office and
profits will be $130.
At a price of $120, both Amanda and Yvonne will
purchase Office and profits will be $240.
By bundling Word and Excel into Office, Microsoft increases
profits.
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