ECON 401 Section: Price Discrimination Sarah E. Taylor University of Michigan, Department of Economics March 16, 2011 The idea behind price discrimination, is that the Monopolist wishes to capture more of the willingness to pay of different consumers to improve profits. There are several methods by which a firm may discriminate between consumers: 1. Perfect Price Discrimination (First-Degree Price Discrimination) • The monopolist knows the willingness to pay (i.e. how much each consumer would pay for a unit of the good) of each consumer and charges them accordingly to extract all of the surplus possible. Notice that this outcome is efficient, but it is just the case that the monopolist extracts all of the surplus and leaves nothing to the consumers. The monopolist will produce until the marginal cost exceeds the willingness to pay. • Example. First-Degree Price Discrimination is primarily a theoretical concept, although the example of Universities offering different tuitions to different students qualifies as a closely related real-world example. A University asks students questions about their household income to estimate their willingness to pay, and accordingly offers them different tuitions via needs-based scholarships. 2. Quantity Discrimination (Second-Degree Price Discrimination) • The monopolist charges different price for different quantities. Customers with different willingness to pay choose different quantities; thereby, the monopolist extracts some surplus from the consumers. • Example. Suppose a consumer is willing to pay $20 for the first sweater she buys and $10 for the next, since after buying the first sweater there is no longer such a dire need to have one. Retail stores, like Gap, will often sell 1 sweaters at “buy one get the second half off” or “buy one for the price of $20 and two for the price of $30”—both such techniques will capture more profits than simply offering each sweater bought at a fixed price of $20, under which scenario only one sweater would be bought by the consumer. 3. Multi-Market Price Discrimination (Third-Degree Price Discrimination) • The monopolist distinguishes between different groups of consumers, where the elasticity of demand differs between groups, and accordingly offers them different prices. Notice that the impact on welfare in this case is ambiguous. • Example. Movie theaters offer different ticket prices to students, adults, and seniors since each group has a different demand for movie tickets. For example, students and senior citizens may be willing to pay less for tickets since their income is potentially less compared to adults. 2