Price Discrimination

What is Price Discrimination? Single-price monopolist are ones that charge all consumers the same price Single-price monopolist are ones that charge all consumers the same price BUT….not all monopolist do this! BUT….not all monopolist do this! Price Discrimination is when sellers charge different prices to different consumers for the same good Price Discrimination is when sellers charge different prices to different consumers for the same good

Price Discrimination What is something we encounter regularly? What is something we encounter regularly? Airline Tickets There are lots of airlines but most routes in the US (or any country/area) are serviced by one or two carriers There are lots of airlines but most routes in the US (or any country/area) are serviced by one or two carriers Passengers regularly ask….”how much will it cost me to fly there?” Passengers regularly ask….”how much will it cost me to fly there?”

Price Discrimination Although….airlines are usually an oligopoly Although….airlines are usually an oligopoly Price discrimination does take place under oligopolies and monopolistic competition and monopolies Price discrimination does take place under oligopolies and monopolistic competition and monopolies Does not happen under perfect competition Does not happen under perfect competition

Definition of Price Discrimination Selling same product at different prices to different customers in order to increase profit Selling same product at different prices to different customers in order to increase profit Profit-maximization quantity if found where MR = MC Profit-maximization quantity if found where MR = MC The profit-maximizing price is the highest price that customers will pay to purchase a good or service The profit-maximizing price is the highest price that customers will pay to purchase a good or service

Principles of Price Discrimination First Principle: First Principle: 1.If the demand curves are different, it is more profitable to set different prices in different markets than a single price that covers all markets GSK and their drug Combivir (HIV) GSK and their drug Combivir (HIV)

Principles of Price Discrimination First Principle Part A: First Principle Part A: 1. a. To maximize profit the firm should set a higher price in markets with more inelastic demand Why? Why? GSK wants to set a higher price for Combivir in Europe than in Africa but we know that setting two different prices leads to smuggling and this means fewer sales for GSK GSK wants to set a higher price for Combivir in Europe than in Africa but we know that setting two different prices leads to smuggling and this means fewer sales for GSK

Principles of Price Discrimination If smuggling is large-scale, GSK will end up selling more of its output at Africa which is less profitable than if GSK set a single world price If smuggling is large-scale, GSK will end up selling more of its output at Africa which is less profitable than if GSK set a single world price What should GSK do (or could do)? What should GSK do (or could do)? If the smugglers can’t be stopped, GSK will abandon price discrimination and set a single world price If the smugglers can’t be stopped, GSK will abandon price discrimination and set a single world price

Principles of Price Discrimination Arbitrage is taking advantage of price differences for the same good in different market by buying low in one market and selling high in another market Arbitrage is taking advantage of price differences for the same good in different market by buying low in one market and selling high in another market Legal term that is applied to special examples of smuggling Legal term that is applied to special examples of smuggling

Principles of Price Discrimination The first principle explains that a firm WANTS to set different prices in different market The first principle explains that a firm WANTS to set different prices in different market The second principle tells us that a firm may not be ABLE to set different prices in different markets The second principle tells us that a firm may not be ABLE to set different prices in different markets How can a firm be successful at price discrimination? How can a firm be successful at price discrimination? The monopolist MUST prevent arbitrage! The monopolist MUST prevent arbitrage!

Principles of Price Discrimination How can a monopolist prevent arbitrage? How can a monopolist prevent arbitrage? Examples: Examples: – GSK can color code the pills, Red for Europe, Blue for Africa – GSK can use special bar codes on each package and can track the distributors – DVDs have region codes that prevent DVDs bought in India being played in US players

Principles of Price Discrimination Second Principle of Price Discrimination: Second Principle of Price Discrimination: – Arbitrage makes it difficult for a firm to set different prices in different markets, thereby reducing the profit from price discrimination Example: Example: – Government taxes alcohol but subsidizes ethanol fuel to prevent arbitrage – Services are difficult to arbitrage

Examples of Price Discrimination Price Discrimination is easy to see: Price Discrimination is easy to see: Movie theatres (senior vs. child prices) Movie theatres (senior vs. child prices) – Why? Child Prices (younger people) have more inelastic demand Airlines (business travel verse vacationing) Airlines (business travel verse vacationing) – Businessmen are less sensitive to the price of an airline ticket than vacationers – How determine? Vacationers buy tickets in advance, businessmen do not

Examples of Price Discrimination Universities are the biggest practioners of price discrimination Universities are the biggest practioners of price discrimination – Hidden under “Student Aid” – Charging different prices for the same good How are universities able to do this? How are universities able to do this? – Determine by tax returns of students & parents Universities are the example of Perfect Price Discrimination Universities are the example of Perfect Price Discrimination

Perfect Price Discrimination Perfect Price Discrimination is when each customer is charges his/her maximum willingness to pay Perfect Price Discrimination is when each customer is charges his/her maximum willingness to pay – If/when each person is charged their maximum willingness to pay, consumers end up with AZERO consumer surplus BUT it will not lead to deadweight loss

Perfect Price Discrimination When a consumer’s willingness to pay is higher than marginal cost, then that consumer is sold a unit of the good – but this means that PPD monopolist produces the efficient quantity When a consumer’s willingness to pay is higher than marginal cost, then that consumer is sold a unit of the good – but this means that PPD monopolist produces the efficient quantity PPD monopolist produces until P = MC, just like a competitive firm PPD monopolist produces until P = MC, just like a competitive firm

Perfect Price Discrimination Remember ALL firms want to produce until MR = MC Remember ALL firms want to produce until MR = MC – Competitive Firm → MR = P – Competitive Firm produces until P = MC – Single-Price Monopolist → MR < P, produces less than a firm

Perfect Price Discrimination What is MR for a PPD monopolist? What is MR for a PPD monopolist?Price Thus the PPD monopolist also sets P = MC Thus the PPD monopolist also sets P = MC – Only done through detailed information – Ex. Retailers asking for your zip code, information = profit Is Price Discrimination Bad? Is Price Discrimination Bad? – PPM producers more output than a single-price monopolist, so price discrimination can’t be bad?

Perfect Price Discrimination Although….what if Price Discrimination is imperfect? Although….what if Price Discrimination is imperfect? – Does a monopolist that sets 2 (or more) prices raise or lower total surplus? – Price Discrimination is bad if the total output with PD falls or stays the same but if output increases, than total surplus will increase

Perfect Price Discrimination Problem → GSK is forbidden from price discriminating so it sets one world price, what price would GSK set? Problem → GSK is forbidden from price discriminating so it sets one world price, what price would GSK set? Would this increase or decrease total surplus? Would this increase or decrease total surplus?

Perfect Price Discrimination GSK could lower the price so Africans can buy the drug easily Pworld GSK could lower the price so Africans can buy the drug easily Pworld Single-price of P world is better for Europe (P world P Africa Single-price of P world is better for Europe (P world P Africa – Depending on how much better off Europeans are and how much worse off Africans are at P world – Price discrimination could be better or worse – But….GSK would most likely not lower P world too low

Price Discrimination & Fixed Cost Profits increase with market size Profits increase with market size – Africans benefit from price discrimination with lower prices – Europeans benefit from the price discrimination increasing the profit from producing pharmaceuticals and more profit will mean more research and development and then more new drugs with equals a greater life expectancy Higher fixed cost industries (airlines, chemicals, universities and software) tends to benefit from price discrimination Higher fixed cost industries (airlines, chemicals, universities and software) tends to benefit from price discrimination

Other Price Discriminations TYPING – a form of price discrimination in which one good (base good) is tied to a second good called a variable good TYPING – a form of price discrimination in which one good (base good) is tied to a second good called a variable good Why are printers cheap but ink expensive? Why are printers cheap but ink expensive? – Profits come from ink Ex. Xbox game consoles are priced below cost but Xbox games are priced above → cell phones are priced below cost but phone calls are priced above Ex. Xbox game consoles are priced below cost but Xbox games are priced above → cell phones are priced below cost but phone calls are priced above

Other Price Discriminations HP is selling a packaged good HP is selling a packaged good – HP wants to charge a high price to consumers with a high willingness to pay but a low price to consumers with a low willingness to pay – Consumers with a high willingness probably want to print lots of color photos but consumers with a low willingness to pay will only print color photos occasionally Higher price for ink means HP is chagrining high willingness to pay consumers a high price Higher price for ink means HP is chagrining high willingness to pay consumers a high price

Other Price Discriminations HP, Xbox and Cell Phones show benefits and costs of price discrimination HP, Xbox and Cell Phones show benefits and costs of price discrimination – Price discrimination can increase output by lowering the price to users who only want to print occasional photos – Due to this, fixed cost can be spread across research and development

Other Price Discriminations “BUNDLING” – goods must be bought in a package “BUNDLING” – goods must be bought in a package Bundling reduces cost Bundling reduces cost This is a form of price discrimination, some can take advantage and some don’t This is a form of price discrimination, some can take advantage and some don’t Microsoft Office verse Microsoft Word, Excel, etc. Microsoft Office verse Microsoft Word, Excel, etc. – Bundling is cheaper than purchasing each program separately if need two or more….

Overall/Summary Price discrimination is same good to different customers at different prices Price discrimination is same good to different customers at different prices Firms price goods based on characteristics that are correlated with willingness to pay Firms price goods based on characteristics that are correlated with willingness to pay Price discrimination requires firms to know about their consumer Price discrimination requires firms to know about their consumer Price discrimination can increase total surplus – increases total surplus when it increase output and when there are large fixed cost of development Price discrimination can increase total surplus – increases total surplus when it increase output and when there are large fixed cost of development

Price Discrimination Notes

What is Price Discrimination? Single-price monopolist are ones that charge all consumers the same price Single-price monopolist are ones that charge all consumers the same price BUT….not all monopolist do this! BUT….not all monopolist do this! Price Discrimination Price Discrimination

Price Discrimination What is something we encounter regularly? What is something we encounter regularly? There are lots of airlines but most routes in the US (or any country/area) are serviced by one or two carriers There are lots of airlines but most routes in the US (or any country/area) are serviced by one or two carriers Passengers regularly ask….”how much will it cost me to fly there?” Passengers regularly ask….”how much will it cost me to fly there?”

Price Discrimination Although….airlines are usually an _______________ Although….airlines are usually an _______________ Price discrimination does take place under oligopolies and monopolistic competition and monopolies Price discrimination does take place under oligopolies and monopolistic competition and monopolies Does not happen under _____________________ Does not happen under _____________________

Definition of Price Discrimination Selling same product at different prices to different customers in order to increase profit Selling same product at different prices to different customers in order to increase profit Profit-maximization quantity if found where ______________________ Profit-maximization quantity if found where ______________________ The profit-maximizing price is the ______________price that customers will pay to purchase a good or service The profit-maximizing price is the ______________price that customers will pay to purchase a good or service

Principles of Price Discrimination First Principle: First Principle: 1.If the demand curves are ____________, it is more ____________ to set different ____________ in different ____________ than a ____________price that covers all markets GSK and their drug Combivir (HIV) GSK and their drug Combivir (HIV)

Principles of Price Discrimination First Principle Part A: First Principle Part A: 1. a. To maximize profit the firm should set a _____ price in markets with more ____________demand Why? Why? GSK wants to set a higher price for Combivir in Europe than in Africa but we know that setting two different prices leads to smuggling and this means fewer sales for GSK GSK wants to set a higher price for Combivir in Europe than in Africa but we know that setting two different prices leads to smuggling and this means fewer sales for GSK

Principles of Price Discrimination If smuggling is large-scale, GSK will end up selling more of its output at Africa which is less profitable than if GSK set a single world price If smuggling is large-scale, GSK will end up selling more of its output at Africa which is less profitable than if GSK set a single world price What should GSK do (or could do)? What should GSK do (or could do)?

Principles of Price Discrimination ____________ is taking advantage of price differences for the same good in different market by buying low in one market and selling high in another market ____________ is taking advantage of price differences for the same good in different market by buying low in one market and selling high in another market Legal term that is applied to special examples of ____________ Legal term that is applied to special examples of ____________

Principles of Price Discrimination The first principle explains that a firm _______ to set different prices in different market The first principle explains that a firm _______ to set different prices in different market The second principle tells us that a firm may not be _______ to set different prices in different markets The second principle tells us that a firm may not be _______ to set different prices in different markets How can a firm be successful at price discrimination? How can a firm be successful at price discrimination? The monopolist _______ prevent arbitrage! The monopolist _______ prevent arbitrage!

Principles of Price Discrimination How can a monopolist prevent arbitrage? How can a monopolist prevent arbitrage? Examples: Examples:

Principles of Price Discrimination Second Principle of Price Discrimination: Second Principle of Price Discrimination: – Arbitrage makes it difficult for a firm to set different _______ in different _______, thereby reducing the _______ from price discrimination Example: Example:

Examples of Price Discrimination Price Discrimination is easy to see: Price Discrimination is easy to see: _______ _______(senior vs. child prices) _______ _______(senior vs. child prices) – Why? ______________ (business travel verse vacationing) ______________ (business travel verse vacationing)

Examples of Price Discrimination Universities are the biggest practioners of price discrimination Universities are the biggest practioners of price discrimination – Hidden under “______________” – Charging different prices for the same good How are universities able to do this? How are universities able to do this? Universities are the example of ____________________________ Universities are the example of ____________________________

Perfect Price Discrimination Perfect Price Discrimination is when each customer is charged his/her _________________________ Perfect Price Discrimination is when each customer is charged his/her _________________________ – If/when each person is charged their maximum willingness to pay, consumers end up with ______ consumer surplus BUT it will not lead to ____________________________

Perfect Price Discrimination When a consumer’s willingness to pay is higher than ______________, then that consumer is sold a unit of the good – but this means that PPD monopolist produces the ____________________________ When a consumer’s willingness to pay is higher than ______________, then that consumer is sold a unit of the good – but this means that PPD monopolist produces the ____________________________ PPD monopolist produces until ______________, just like a ______________ firm PPD monopolist produces until ______________, just like a ______________ firm

Perfect Price Discrimination Remember ________ firms want to produce until ___________ Remember ________ firms want to produce until ___________ – Competitive Firm → ______________ – Competitive Firm produces until ________ – Single-Price Monopolist → ___________, produces less than a firm

Perfect Price Discrimination What is MR for a PPD monopolist? What is MR for a PPD monopolist? Thus the PPD monopolist also sets ________ Thus the PPD monopolist also sets ________ – Only done through detailed information Is Price Discrimination Bad? Is Price Discrimination Bad? – PPM producers more output than a single-price monopolist, so price discrimination can’t be bad?

Perfect Price Discrimination Although….what if Price Discrimination is ______________? Although….what if Price Discrimination is ______________? – Does a monopolist that sets 2 (or more) prices, raise or lower total surplus? – Price Discrimination is bad if the total __________ with price discrimination _________or stays the same but if output __________, than ____________will increase

Perfect Price Discrimination Problem → GSK is forbidden from price discriminating so it sets one world price, what price would GSK set? Problem → GSK is forbidden from price discriminating so it sets one world price, what price would GSK set? Would this increase or decrease total surplus? Would this increase or decrease total surplus?

Perfect Price Discrimination GSK could lower the price so Africans can buy the drug easily P world GSK could lower the price so Africans can buy the drug easily P world Single-price of P world is better for Europe (P world P Africa Single-price of P world is better for Europe (P world P Africa – Depending on how much better off Europeans are and how much worse off Africans are at P world – Price discrimination could be better or worse – But….GSK would most likely not lower P world too low

Price Discrimination & Fixed Cost Profits increase with ______________ Profits increase with ______________ – Africans benefit from price discrimination with __________________ – Europeans benefit from the price discrimination increasing the profit from producing pharmaceuticals and more profit will mean more _________ and _________ and then more new drugs with equals a greater __________________ _________ fixed cost industries (airlines, chemicals, universities and software) tends to benefit from price discrimination _________ fixed cost industries (airlines, chemicals, universities and software) tends to benefit from price discrimination

Other Price Discriminations __________________– a form of price discrimination in which one good (base good) is tied to a second good called a variable good __________________– a form of price discrimination in which one good (base good) is tied to a second good called a variable good Why are printers cheap but ink expensive? Why are printers cheap but ink expensive? Ex. Xbox game consoles are priced below cost but Xbox games are priced above → cell phones are priced below cost but phone calls are priced above Ex. Xbox game consoles are priced below cost but Xbox games are priced above → cell phones are priced below cost but phone calls are priced above

Other Price Discriminations HP is selling a packaged good HP is selling a packaged good – HP wants to charge a high price to consumers with a high willingness to pay but a low price to consumers with a low willingness to pay – Consumers with a high willingness probably want to print lots of color photos but consumers with a low willingness to pay will only print color photos occasionally Higher price for ink means HP is charging high willingness to pay consumers a high price Higher price for ink means HP is charging high willingness to pay consumers a high price

Other Price Discriminations HP, Xbox and Cell Phones show benefits and costs of price discrimination HP, Xbox and Cell Phones show benefits and costs of price discrimination – Price discrimination can increase _________ by lowering the price to users who only want to print occasional photos – Due to this, _________can be spread across _________ and _________

Other Price Discriminations __________________– goods must be bought in a package __________________– goods must be bought in a package Bundling reduces _________ Bundling reduces _________ This is a form of price discrimination, some can take advantage and some don’t This is a form of price discrimination, some can take advantage and some don’t __________________verse _________, Excel, etc. __________________verse _________, Excel, etc. – Bundling is cheaper than purchasing each program separately if need two or more….

Overall/Summary Price discrimination is same good to different customers at different prices Price discrimination is same good to different customers at different prices Firms price goods based on characteristics that are correlated with ________________ Firms price goods based on characteristics that are correlated with ________________ Price discrimination requires firms to __________________ Price discrimination requires firms to __________________ Price discrimination can increase __________________– increases total surplus when it increase output and when there are large fixed cost of development Price discrimination can increase __________________– increases total surplus when it increase output and when there are large fixed cost of development