Advanced Microeconomic Theory II - Fall 2011
Outline – Price Discrimination [Chapter 3]
Notes:
 Transferability of the good
 Transferability of demand
 First-degree, or perfect discrimination, is not likely. Charging each the maximum price
he is willing to pay.
 Second-degree, in which people choose a product from a menu, so that they self-select
into a group.
 Third-degree, in which the producer receives a signal about demand of a type of
consumer and can differentiate based on that characteristic (like student discounts).
3.1 – Perfect Price Discrimination
3.2 – Multimarket Price Discrimination (3rd degree)
3.2.1 – Inverse Elasticity Rule
The monopolist produces a single good that he can divide into groups on the
basis of exogenous information (for example, one movie showing, multiple
prices. Optimal pricing implies that the monopolist should charge more in markets with
the lower elasticity of demand.
3.2.2 – Welfare Aspects
Consumers in low-elasticity markets are adversely affected and would prefer a
uniform price; consumers in high-elasticity markets prefer discrimination.
Price discrimination redistributes income away from low-elasticity groups
towards high-elasticity groups and the monopolist.
3.2.3 – Applications
Spatial Discrimination
Transportation cost per unit is proportional to the distance to the plant. Freight
absorption is commonly observed in practice. The possibility of arbitrage may
not be the only explanation for this. In some cases, the demand function may
not be the same across all locations. Elasticity of demand increases with
distance to the factory.
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Vertical Controls
A monopolist produces a good used as in input by two competitive industries
producing different final goods. The final goods face independent demands.
Vertical integration can be used as a substitute for price discrimination, when an
upstream firm cannot control the resale of its product among its buyers.
3.3 – Personal Arbitrage and Screening (2nd degree)
A monopolist faces demand composed of heterogeneous consumers but cannot tell the
consumers apart.
3.3.1 – Two-part tariffs
A two-part tariff offers a menu of bundles. This is actually a quantity-discount
scheme whereby the average price of the good decreases with the number of
units bought.
3.3.2 – Fully Nonlinear Tariffs and Quantity Discrimination
Conclusion 1: Low-demand consumers derive no net surplus, while high-demand
consumers derive a positive net surplus.
Conclusion 2: The binding personal-arbitrage constraint is to prevent highdemand consumers from buying the low-demand consumers’ bundle.
Conclusion 3: The high-demand consumers purchase the socially optimal
quantity, while the low-demand consumers purchase a suboptimal quantity.
3.3.3 – Quality Discrimination
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