Chapter 9: Monopoly Price Discrimination

n Price discrimination refers to any complicated price strategy that tries to extract consumer surplus and deadweight loss, so as to increase profits, relative to the benchmark case of uniform pricing n First degree price discrimination, a.k.a., perfect price discrimination n Second degree price discrimination: consumers are given a menu of packages to choose from n Third degree price discrimination: customers have identifiable difference, and resale between customers is (naturally or made) difficult

First degree price discrimination n For instance, each student wants to buy one unit of notebook computer but has a different maximum willingness to pay n Under first degree price discrimination, every customer is charged his/her maximum willingness to pay n In case of heterogeneous customers, this is quite unlikely and represents an ideal case.

First degree price discrimination n In case of homogenous customers, this brings us to the idea of membership fees. n Suppose each HKU faculty member’s monthly demand for meals in its common room is the same, denoted by P = 500 – 80Q n Suppose the marginal cost of each meal is $20.

Membership fee Q P Under uniform pricing: MR=MC=>Q*=3, P*=260 Perfect price discrimination =>membership fee: A+B+C Each meal’s price = $20 A B C Socially optimal output 20

Second degree price discrimination n Give a menu of price packages and let the customers choose which one to accept n High fixed fee + low per unit fee n Low fixed fee + high per unit fee n High usage customers choose the former; low usage customers choose the latter.

Third Degree Price Discrimination n Arcadia Publisher is planning to publish a book. –loyalty to the author is fixed at $2M –production cost=$0 per copy –two groups of buyers 100K group 1 readers--each willing to pay up to $30 400K group 2 readers--each willing to pay up to $5 n If p= $30, only group 1 readers will buy the book. Arcadia obtains $30x100K =$3M (gross of loyalty) n If p= $5, both groups of readers will buy the book. Arcadia obtains $5x500K=$2.5M (gross of loyalty) n Hence, charging $30 is better.

Price Discrimination n Now suppose Arcadia knows that all group 1 readers are in HK and group 2 readers are in Chile. Then it can charges a fee of $30 for a book sold in HK and $5 for a book sold in Chile. n Price discrimination leads to –greater profits –greater social welfare!!

Determination of differentiated prices under constant marginal cost

Evidence of Geographic Price Discrimination n Parallel imports--unauthorized flows of genuine products across countries that compete with authorized distribution channels (ranging from deluxe cars to cheap beer) n It is often thought that parallel imports of HK made movie and music products back into HK market adversely affects the very survival of HK movie and music industry.

Price Discrimination: How to separate different customers n Coupons (i.e., hurdle)--those people who have lower time cost will collect and use coupons to get a discount; they are likely to have lower maximum willingness to pay as well n In 1999, CTI charged different fees for its registered IDD users--37cents/min to US for smart users who made a double registration; $2.9 /min for not-so- smart users who did not (c.w. HKTC’s 001 and 0060). n Educational edition--software companies charge a substantial lower price to teachers and students for their software

Price Discrimination: How to separate different customers n Hardcover vs paperback--readers of lower maximum willingness to pay are more patient; hence publishing a paperback later attract these buyers without affecting sale to hardcover buyers (compared w. seasonal sales in department stores)--production differentiation in general n Different prices for different geographic locations –golf clubs are much more expensive in HK than in the US (HK$4.5K vs US$250) –tennis ball--HK’s price is two or three times that in the US