First thru Third Degree Price Discrimination

First-Degree Price Discrimination Under first-degree price discrimination, each customer is charged the highest price they are willing and able to pay. Example: Dutch auction The monopolist can capture the entire consumer surplus. Apple: IPod releases Initial high price Price lowered 6 months later

Simple Single Priced Monopolist Monopolist sets only 1 price for all customers\ First chooses Q* such that MR(Q*) = MC(Q*) – here at Q1 Then sets price at max price consumer will pay for Q1 units – here P1 CS extracted by Monopolist

Welfare with and without price discrimination 9 Welfare with and without price discrimination (a) Monopolist with Single Price (b) Monopolist with Perfect Price Discrimination Price Price Consumer surplus Demand Marginal revenue Profit Demand Deadweight loss Monopoly price Profit Quantity sold Marginal cost Marginal cost Quantity sold Quantity Quantity Panel (a) shows a monopolist that charges the same price to all customers. Total surplus in this market equals the sum of profit (producer surplus) and consumer surplus. Panel (b) shows a monopolist that can perfectly price discriminate. Because consumer surplus equals zero, total surplus now equals the firm’s profit. Comparing these two panels, you can see that perfect price discrimination raises profit, raises total surplus, and lowers consumer surplus.

First Degree Price Discrimination Charge consumer Max price for each unit purchased PPD Monopolist charges a different price for each unit sold to the consumer

Simple (single price) Monopolist and Perfect Price Discrimination All CS lost to PPD Monopoly CS lost to simple monopoly

Restricting Quantity and Price Discrimination Charge price = sum(WTP)/Qsold Extract all CS P-PC TR MR MC CS-PC 10 4 9 18 8 $1 3 only 24 6 $3 p=$9 CS= 0 7 28 $6 M-1P 30 2 $10 6 only pay WTP CS = 0 5 $15 7.5 45 $45 -2 $21 PC 3 -4 $28 -6 $36 1 -8

Third degree price discrimination Charge different prices in different markets Charge Max WTP for each customer Major problem – need to prevent resale from customer with lower WTP to customer with higher WTP

Price Discrimination Lessons from perfect price discrimination Rational strategy Increase profit Charges each customer a price closer to his or her willingness to pay Sell more than is possible with a single price

Price Discrimination Lessons from price discrimination Requires the ability to separate customers according to their willingness to pay Certain market forces can prevent firms from price discriminating Arbitrage – buy a good in one market, sell it in other market at a higher price Can raise economic welfare Can eliminate the inefficiency of monopoly pricing More consumers get the good Higher producer surplus (higher profit)

Price Discrimination The analytics of price discrimination Perfect price discrimination Charge each customer a different price Exactly his or her willingness to pay Monopolist - gets the entire surplus (Profit) No deadweight loss Without price discrimination Single price > MC Consumer surplus Producer surplus (Profit) Deadweight loss

Second-Degree Price Discrimination Second-degree price discrimination occurs when firms sell their product at a discount when consumers buy large quantities. Example: Electricity prices? Costco/Sam’s Club – “Big Box Stores” http://www.amosweb.com/cgibin/awb_nav.pl?s=wpd&c=dsp&k=second- degree+price+discrimination

Third-Degree Price Discrimination Under third-degree price discrimination, a firm charges different prices in different markets for their product. The most common form of price discrimination Examples include: Children's discounts Senior citizen’s discounts Airfares Different geographic markets (Madison Park, U District)

To Be Able to Do Price Discrimination To be a successful price discriminator, a seller must satisfy three conditions: (1) to have market control and be a price maker, (2) to identify two or more groups that are willing to pay different prices, and (3) to keep the buyers in one group from reselling the good to another group.

A Word from the FTC on Discriminatory Pricing A seller charging competing buyers different prices for the same "commodity" or discriminating in the provision of "allowances" -- compensation for advertising and other services -- may be violating the Robinson-Patman Act. This kind of price discrimination may hurt competition by giving favored customers an edge in the market that has nothing to do with the superior efficiency of those customers. However, price discriminations generally are lawful, particularly if they reflect the different costs of dealing with different buyers or result from a seller’s attempts to meet a competitor’s prices or services.

A Word from the FTC on Discriminatory Pricing A seller charging competing buyers different prices for the same "commodity" or discriminating in the provision of "allowances" -- compensation for advertising and other services -- may be violating the Robinson-Patman Act. This kind of price discrimination may hurt competition by giving favored customers an edge in the market that has nothing to do with the superior efficiency of those customers. However, price discriminations generally are lawful, particularly if they reflect the different costs of dealing with different buyers or result from a seller’s attempts to meet a competitor’s prices or services.

3 Major Pieces of Legislation to address Anti-Competitive Markets Sherman Anti-trust Act (1890) Anti-competitive behavior, mergers Clayton Act (1914) Price discrimination (simple) Tie-in sales Robinson-Putman (1936) More detailed/complex definition of price discrimination Copyright © 2006 Pearson Addison-Wesley. All rights reserved.

Sherman Anti-trust Act As explained by the U.S. Supreme Court in Spectrum Sports, Inc. v. McQuillan, “ The purpose of the [Sherman] Act is not to protect businesses from the working of the market; it is to protect the public from the failure of the market. The law directs itself not against conduct which is competitive, even severely so, but against conduct which unfairly tends to destroy competition itself The law attempts to prevent the artificial raising of prices by restriction of trade or supply.[4] Copyright © 2006 Pearson Addison-Wesley. All rights reserved.

Sherman Anti-Trust Act Divided into three sections. Sec 1 delineates and prohibits specific means of anticompetitive conduct, (e.g., contracts/agreements) Sec 2 deals with end results that are anticompetitive in nature. (actual pricing tactics, or non-compete) Sec 3 simply extends the provisions of Section 1 to U.S. territories and the District of Columbia. Copyright © 2006 Pearson Addison-Wesley. All rights reserved.