Ch. 9 Price discrimination

Price discrimination Definition: It is the practice of charging different prices to different buyers (or groups of buyers) for essentially the same good The price difference does not reflect cost difference.

First-degree Price Discrimination It implies that the seller is charging each consumer the maximum amount that he or she is willing to pay for an extra unit of the goods. It is also known as perfect price discrimination.

First degree price discrimination demand curve D=MUV=MR MC P Q Consumer Surplus

Third-degree Price Discrimination It is a situation whereby the seller can charge different prices in two or more different markets at the same time. The seller can extracts part of the consumer’s surplus. It is also known as market segmentation

1.Decide what total output Q* should be MC=MR 2.How this output should be distributed among separate mkt. 3.What price should be in each market Lower elasticity will face a higher price Market AMarket B Both markets MC P PP Q QQ P1 P2 Q* QbQa inelasticelastic

Market segmentation optimal condition: MC=MRa+b = MRa= MRb Market AMarket B Both markets MC P PP Q QQ P2 Q* QbQa P1 MR<MC   QMR>MC   Q If MRa  MRb, it is possible to reallocate the output in order to  TR

Price Discrimination or not? 1.Medical care –Yes, different price same service 2.Tuition fees – scholarships Yes, different price same education Better student are more elastic 3.Hotels charge lower prices to commercial clients –Yes. Commercial clients are more elastic.

Price Discrimination or not? 4. Interest Loan –No, the costs of the small loan are larger per dollar –Different financial reliabilities 5. Student discounts e.g. MTR –Yes, lower price for the same seat 6. Peak-hour pricing –No, differences in the marginal costs of serving customers during peak hours and off-peak hours

Conditions of Price Discrimination 1.Monopoly power 2.Separable market 3.Different demand elasticities But according to Professor Cheung, the essence of price discrimination is buyers do not possess perfect information regarding the prices charged by the seller.

Pricing Tactics for Extracting Consumer’s Surplus 1.All-or-nothing pricing 2.A two-part tariff or licensing 3.A tie-in contract

1. All-or-nothing pricing is a means of extracting the consumer’s surplus by denying the consumer the choice of how much of a good to purchase. The consumer must either buy the whole package or none at all.

All-or-nothing pricing QuantityMUV= MR TUV =TR AUV MUV=MR AUV all-or-nothing demand curve 9 8

To maximize wealth, the seller will produce at Q1 where MC=MR=MUV Then charge an all-or-nothing price which is equal to the AUV TR = AUV* Q1 = TUV MUV=MR all-or-nothing demand curve MC AUV P Q1 –Consumer surplus is extracted. –2 triangles are exactly the same. Unless each consumer is charged a different all-or- nothing price, there is no price discrimination

2. A two-part tariff or licensing It is a tariff in which a person is asked to pay a lump-sum fee for the right to buy a good first, and then has to pay another sum for each unit bought.

Lump-sum fee or tariff D=MUV=MR MC Q Lump-sum fee Q1 P1 P -The lump sum fee exhausts the entire consumer’s surplus -A monopolist can charge different lump-sum fees to different consumers in order to extract all the consumer surplus. -it is equivalent to first-degree price discrimination.

3. A tie-in contract It is an offer to sell a good at a given price on the condition that the buyer also buys another good at a stated price. D=MUV=MR MC Q Tied good Q1 P1 P The consumer will agrees to this if CS can cover the amount paid for the tied good.

Allocative Inefficiency? Under simple monopoly pricing, a monopolist will produce Q1 at which MR=MC & charges P1 which is greater than MC. The shade area is deadweight loss. MR MC P Q1 deadweight loss MUV=P Q

Allocative Inefficiency? However, as a maximizer, a monopoly can exploit the potential gain by using first-degree price discrimination. MR1 MC P Q1 MUV Q MR2=MUV MUV=MR2=MC Q2 Can be as efficient as a price taker.

Why still adopt simple pricing? Inefficiency occurs? No, we need to consider the transaction costs. If transaction cost > deadweight loss Still efficient by adopting simple pricing. Inefficiency means there is still potential gain!