Price Discrimination 1

Defined: Sellers engage in price discrimination when they charge different prices to different consumers for the same good, because the willingness to pay varies across buyers. 2

Price Discrimination Occurs in 2 Market Structures: Monopoly Oligopoly Examples: Airlines Cinemas Public Transportation 3

Requirement for Price Discrimination To be able to price discriminate, a firm must: – Identify and separate different types of buyers – Sell a product that cannot be resold – Example: An airline separates business and leisure travellers, and requires identification to be shown to board the plane. 4

Price Discrimination and Consumer Surplus The key idea behind price discrimination is to convert consumer surplus into economic profit. nom…nom...nom 5

Before Price Discrimination – The firm sets one price, equal to the maximum consumer willingness to pay, – Where MC is = to MR – This results in consumer surplus, producer surplus (economic profit), and – dead weight loss) 6

Economic profit is increased, and consumer surplus is diminished Example: Diagram shows a 4-price monopolist. The increase in producer surplus is the three darker blue rectangles. 7 After Price Discrimination

Perfect Price Discrimination Is price discrimination that extracts the entire consumer surplus by charging the highest price that consumers are willing to pay for each unit. – Very difficult/Impossible because it requires identifying a separate customer group for each and every price point on the demand curve. – The demand curve becomes the MR curve. The next customer on the demand is charged the maximum price that they are willing to pay – More difficult to achieve than dividing airplane passengers into business or leisure. 8

Result of Perfect Price Discrimination All consumer surplus is eliminates Output is increased (equal to that as under perfect competition) – Recall – the D curve is now the MR curve Deadweight loss is eliminated (now zero). Efficient 9

Efficiency Compared to Perfect Competition There is one key difference between perfect competition and perfect price discrimination The distribution of the total surplus is different It is shared by consumers and producers in perfect competition The producer gets it all in perfect price discrimination 10

Efficiency Compared to Perfect Competition Efficient Outcome: is one in which scarce resources are allocated to their highest value use. Efficient Allocation of Resources: – Resources are used efficiently when it is not possible to get more of one good – without giving up something that is valued more highly. – When this is achieved, MB is = to MC and total surplus is maximized. 11

Efficiency in a Perfectly Competitive Market First  We derive a firms supply curve from its MC curve at all points above the AVC  The market Supply curve is the sum of the quantity supplied by all firms at  each price.  The market Supply curve is the entire market’s MC curve 12

Efficiency in a Perfectly Competitive Market Second  The market demand curve is the marginal benefit curve. The demand curve  shows the additional benefit that is derived from consuming one more unit. 13

Efficiency in a Perfectly Competitive Market Third  The market supply and market demand curve intersect at the equilibrium  price.  The equilibrium price is where MC = MB 14