Price Discrimination Carmel Secondary School

1. same product with 2. same production costs to 3. different buyers at 4. different prices Price Discrimination (PD) is seller selling the…. E.g. Similar chicken with same production cost to different buyers with different prices at the same place.

PD exists because sellers want to extract consumer surplus However, to impose price discrimination, sellers have to fulfill several conditions …

Seller must have monopoly power over the product ; Buyers must have different price elasticity on the same product ; (willing to pay different price) Markets can be separated. (resell is prevented)

Seller have lower Information cost than buyer. (buyer willing to pay higher price : cost of obtaining information > loss in paying higher price) Information costs include those costs of obtaining information of trade.

The gain in using PD (extracted consumer surplus) > Transaction cost of using PD Or The two models both try to explain the fact of PD Furthermore, seller will only use PD when transaction cost incurred is insignificant

There are two types PD : 1.First degree PD (extract all CS) - charging along demand curve - required perfect knowing on buyers MUV 2.Third degree PD (extract part of CS) - charge different prices of same product on - different buyers with independent demands

Case 1 Price Discrimination caused by the difference in price elasticity of demand

My son, Do you know why I have to pay more than you while traveling by MTR and ? Oo…is it the MTR and impose a price discrimination on us? CASE 1 Can you try to explain further? Ok !

Mummy, let me try to explain…According to Dr George Strigler, Different buyers have different price elasticity of demand. In order to impose price discrimination, the MTR company has to separate the market into student and adult markets. Students are more price elastic than adult, because their time cost are relatively lower, if MTR charge them a high price, they will choose other substitutes. So MTR charge them with a lower price. To identify students, MTR give students a Student Travel Card. So MTR can separate the markets successfully. So students can pay a lower price than adult !! Since the cost of serving them is the same, so it is price discrimination. Case 1

Well done ! You are so smart. I give this chicken leg to you. YEAH CASE 1

Case 2 Price Discrimination caused by Information costs

Why is this tourist willing to pay a much higher price than me for the same product ? Temple Street Case 2 Tourist

Dear sister….would you mind telling me why tourist always willing to pay such a high price for the goods in Hong Kong?? It is because their information cost is relatively higher than locals …..So the sellers price discrimination them …. Information cost ?? Whats that ?? WELL…Let me explain it to you….. According to Dr. Steven Cheung, one who has a higher information cost is more likely to be price discriminated by a seller. As the cost of obtaining information is high…buyer with high information cost will be willing to pay a higher price. It results a price discrimination then…. Then…..are all tourists have high information cost and eventually lead to PD ? Well…baby…..the answer is NO ! Let me illustrate it with an example… Case 2

Example Tourist Seller I am just returned from USA and I will stay here for 3 months…..Yet I want to buy a camera first….. Ooo….he is a tourist ….he must have a high information cost….I can charge him a high price then….hehe Hi…..I know you are a tourist….You just come to a right place….You can find everything here….and their prices are reasonable…. Waaaaa…..he must think I am a tourist and necessary to have a high information cost….so he wants to price discriminate me….. However, Im going to stay in Hong Kong for 3 months. My time cost of obtaining information is much lower than a normal tourist because I have a lot of time to search information. So ….my information cost is not high ….Haha…..he want to charge me a high price ?!…NEVER !! Sorry …I dont think the price of your products is suitable for me….Bye Bye

So ….tourists are not necessary to have high information costs… Information costs contain various costs…. local people may also have high information costs….. If they give up the chance of continuing their tours to obtain information….they may even suffer a high loss……..Thats why they are willing to pay more. Case 2 However…how can you ensure a local people can buy the same product as the tourist at the same place with a cheaper price ?? If a local people just buy at the same price…..it is not price discrimination…. Well…baby…we cant ensure it…but a local people usually get more information than a tourist about the local market …. So their bargaining power are usually higher…. So it is less likely to pay a higher price…. price discrimination then exists ?? Exactly baby….!! In many cases just like this example,normally, tourist have high information cost are because their time cost is very high.They lack time to obtaining sufficient information….

………. Ok ….I see…. CASE 3 May I ask you one question?? PD are divided into 1 st and 3 rd degree PD? Isnt it ? …………… Are you talking about first degree and third degree PD ? YES ! Well ! Aunt do you know what is first degree PD? Good question ! Let see. Of course….

$/P Q 0 MR MC P AR=D=MV Qd = consumer surplus AV CASE 3 Fig 1 Simple monopoly pricing Refer to Fig 1 Originally, the seller produce when MC cut MR at Qd and price is P…. Then….. the Red area will be the consumer surplus….

A (1 st Degree) Simple monopoly pricing $/P Q 0 MC AR=D=MV Qd = consumer surplus AV CASE 3 Fig 2 = P P2P2 Q2Q2 MR P3P3 B So, charging the area P 2 0Q 2 B is the same as charging the area P 3 0Q 2 A….. Since mathematical proved that two yellow triangles are identical …. Haha….Do you understand what is 1 st Degree PD? However, under 1 st PD, AR curve of Simple monopoly pricing (SMP) will equal to MR and MV curve. AV curve of SMP will equal to AR curve …… Therefore, this time not only part of consumer surplus, but whole of it will be captured by seller !! The seller charges buyers with the area P 2 0Q 2 B …… Again….seller will produce at MC cut MR…

Also…..the seller has to prevent resale among buyers…..It may require a very high transaction cost in doing so….. However,1 st PD is a very extreme case…the seller require…… CASE 3 It is impossible in the real world. How can a seller know all about his buyers preference? Therefore….it is difficult to find a real example to illustrate it !

Question 1 If a doctor charges his clients the same service charge and sells them the same medicines with different prices, is it considered as a kind of PD? A. Yes B. No

The answer is YES not because the service charge, but the different prices for the medicines. For the cost of buying and distributing/selling these medicines are the same, charging different clients with different prices is a kind of PD.

Question 2 Is the telephone company charges more for IDD calls during rush hours practicing price discrimination ? A. Yes B. No

The answer is NO.Since the cost of providing IDD services is higher during rush hours (the workload of the computer servers maybe higher).For a higher cost… charging a higher price is not PD.

Question 3 A can of soft drink is sold at a higher price in a hotel than in a supermarket. Is this price discrimination? A. Yes B. No

The answer is NO. As the hotel mainly serves tourist, the cost of serving them is usually higher (e.g. waiters are always required to have good English speaking skills ) For a higher serving cost, Charging a higher price is not PD.

From sellers point of view, if the gain of practicing PD from trade can cover the transaction cost involved, we had better to practice PD to capture consumer surplus. Price discrimination can be divided into 1 st Degree and 3 rd Degree price discrimination. There are many example of PD in our live such as MTR. You can find them out if you pay more attention. However, to practice or not depends on the transaction cost involved. Price discrimination can help seller to extract consumer surplus. There are two model of economics in explaining PD, one from Professor George Strigler, one from Professor Steven Cheung.

Carmel Secondary School 6B Chan Chung Hon 6B Poon Tai Yin 6B Yip Tsz To