Price Discrimination

Price Discrimination Defined ▫Single-price monopolist  A monopolist who charges everyone the same price.  Not all monopolists do this. ▫Price Discrimination  Many monopolists find that they can increase their profits by selling the same good to different customers for different prices.  Example: airline tickets  This is seen not only in monopolies but also oligopolies and monopolistic competition.

The Logic of Price Discrimination ▫Why is it more profitable?  Example:  Assume an airline offers the only nonstop flight between Bismarck, ND and Ft. Lauderdale, FL. Also assume no capacity problems (airline can fly as many planes as the number of passengers warrants). Assume no fixed costs. MC = $125 of providing a seat to however many passengers it has.

 2 types of passengers: Business travelers and Student travelers ▫Business: 2000 want to travel each week between the two destinations. Also business travelers need to fly and will pay no more than $550. Assume that if the airline cuts the price it will not lead to an increase in business travel. ▫Students: 2000 want to travel each week between the two destinations. Students have less money and more time and will not pay above $150 or they will take the bus.

▫Realistically there is some “give” in the demand of each group.  If price fell below $550, there would be some increase in business travel  Also at a price above $150 some students would still purchase tickets. ▫Both groups differ in their sensitivity to price.  As long as different groups of customers respond differently to price, a monopolist will find that it can capture more surplus and increase its profit by charging them different prices.

Price Discrimination and Elasticity ▫A more realistic description of demand a monopolist face is to distinguish between different customers based on their sensitivity to price (their price elasticity of demand).  Example: Business travelers vs. Student travelers  Business travelers are very insensitive to price. ▫There is a certain product they have to have whatever the price, but they cannot be persuaded to buy much more than that no matter how cheap it is.  Student travelers are more flexible. ▫Offer a good enough price and they will buy quite a lot; raise the price to high and they will switch to something else.

Perfect Price Discrimination ▫Notice that there is no consumer surplus. The entire surplus is captured by the monopolist.  When a monopolist is able to accomplish this we say the monopolist has achieved perfect price discrimination. ▫In general, the greater number of different prices charged, the closer a monopolist is to perfect price discrimination

▫Two things become apparent  The greater the number of prices the monopolist charges, the lower the lowest price- that is, some customers will pay prices that approach marginal cost.  The greater the number of prices the monopolist charges, the more money extracted from customers ▫a very large number of different prices, will result in a case of perfect discrimination  Every customer pays the most he or she can pay and the entire surplus is extracted as profit.

▫Monopolists do try to move in the direction of perfect price discrimination through a variety of pricing strategies.  Advanced purchase restrictions:  Prices are lower for those who purchase well in advance.  This separates those who are likely to shop for better prices from those who won’t.  Volume discounts:  Often the price is lower if you buy a larger quantity.

 Two-Part Tariffs:  In a discount club like Costco or Sam’s Club, you pay an annual fee (1 st part of the tariff) in addition to the price of the item(s) you purchase (2 nd part)  So the full price of the item you buy is in effect much higher than that of subsequent items, making the two- part tariff behave like a volume discount. ▫Government policies often focus on preventing deadweight loss, not preventing price discrimination, unless it causes issues with equity.