Pricing
Perloff Chapter 12
Why price discriminate
• Downward sloping demand curve implies
that consumers are prepared to pay differing
prices for the good.
• Two reasons for higher profit:
– Higher price to those prepared to pay it;
– More sales through the lower price to those
unwilling to pay the uniform price.
Conditions for price
discrimination
• Market power
– Ability to change the price it charges
• Consumers must differ either:
– in their individual willingness-to-pay for
different units of the good
– in different consumers having different
willingness-to-pay for the good
• Prevent resale
Types of price discrimination
• Perfect (first degree):
– Each unit of the good is sold at its maximum
price.
• Quantity (second degree):
– Price determined by the volume of sales.
• Multimarket (third degree):
– Different groups charged different prices.
p, $ per unit
Perfect price discrimination
6
5
e
4
MC
3
Demand, Marginal revenue
MR 1 = $6 MR 2 = $5 MR 3 = $4
2
1
0
Source: Perloff
1
2
3
4
5
6
Q, Units per day
The efficiency of
p, $ per unit
p
perfect price
discrimination
1
A
ps
B
pc =MC c
MC
es
C
ec
E
D
MCs
Demand, MR d
MC1
MR s
Q s Qc= Q d
Source: Perloff
Q, Units per day
Quantity discrimination
• firm does not know which customers have highest
reservation prices
• firm might know most customers are willing to
pay more for first unit (demand slopes down)
• firm varies price each customer pays with number
of units customer buys
– price varies only with quantity: all customers pay the
same price for a given quantity
• Various forms
– Bulk discounts
– Block pricing
Block pricing (individual consumer)
(a) Quantity Discrimination
p1, $ per unit
90
70
(b) Single-Price Monopoly
p 2 , $ per unit
90
A=
$200
E = $450
60
C=
$200
50
B=
$1,200
30
D=
$200
F = $900
m
G = $450
30
m
Demand
Demand
MR
0
Source: Perloff
20
40
90
Q, Units per day
0
30
90
Q, Units per day
Multimarket pricing
(a) Japan
(b) United States
pJ , $ per unit
p US , $ per unit
4,500
3,500
CSUS
pUS = 2,500
CSJ
pJ = 2,000
DJ
pUS
pJ
DUS
DWLJ
500
MC
DWLUS
500
MRJ
0
Source: Perloff
QJ = 3,000
7,000
QJ, Units per year
MC
MR US
0
QUS = 2,000
4,500
Q US, Units per year
Profit maximising multimarket
equilibrium
MRJ  m  MRUS


1
1 
pJ 1    pUS 1 



J 
US 



1 
1   
pJ
US 

pUS

1
1   
J 

1 

1 

pJ
1.5  0.33


pUS
0.5
 1
1

 2 
Efficiency of multimarket equilibrium
(b) United States
p, $ per unit
p, $ per unit
(a) Japan
4,500
3,500
CSUS
pUS = 2,500
CSJ
pJ = 2,000
DJ
πUS
πJ
DWLJ
DWLUS
MC
500
Source: Perloff
QJ = 3,000
7,000
QJ , Units per year
MC
500
MRJ
0
DUS
MRUS
0
QUS = 2,000
4,500
QUS, Units per year
Efficiency of multimarket equilibrium
• Compared with competition, multimarket
equilibrium is inefficient.
• Compared with a single price monopolist it
the effect on efficiency is unclear.
– Deadweight loss is likely to be reduced because
we move closer to perfect price discrimination.
– A new source of inefficiency is introduced.
Consumers waste time looking for the best deal
and the opportunity to trade with one another.
Two part tariff
• To purchase a good consumers pay:
– A fixed fee
– A fee which varies with the amount consumed
• Telephone companies, Newcastle United season
tickets.
• Principle:
– Set price to maximise consumer surplus.
– Charge an amount equal to the consumer surplus to
participate.
Two part tariff with identical consumers
p, $ per unit
80
D1
A 1 = $1,800
20
10
0
Source: Perloff
C1 = $50
B 1 = $600
m
60 70 80
q 1, Units per day
Two part tariff with different consumers
(a) Consumer 1
(b) Consumer 2
p, $ per unit
100
p , $ per unit
80
D2
D1
A2=$3,200
A1=$1,800
20
10
0
Source: Perloff
B1 = $600
C2=$50
C1=$50
m
607080
q1, Units per day
20
10
0
B2=$800
m
8090100
q2, Units per day
Tie in sales
• Customers buying a product are required to make
subsequent purchases of a related product from the
same firm.
– Car parts
– Printer cartridges
• Producer surplus increases at the expense of
consumers.
• Efficiency probably increases because transaction
costs are lowered.
Bundling
• Firms selling two or more goods can charge
a price for a combination of goods.
– Meal deals.
• Bundling is profitable if willingness to pay
for goods is negatively correlated across
consumers.
– Consumers who are prepared to pay a high
price for a burger have a low willingness-to-pay
for the drink.