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Maximizing Profits through Price Discrimination Strategies

This chapter explores first, second, and third-degree price discrimination strategies in monopolies to increase profits. Examples include perfect price discrimination and differentiated pricing based on customer segments.

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Maximizing Profits through Price Discrimination Strategies

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  1. Chapter 9: Monopoly Price Discrimination

  2. Price Discrimination • 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 • First degree price discrimination, a.k.a., perfect price discrimination • Second degree price discrimination: consumers are given a menu of packages to choose from • Third degree price discrimination: customers have identifiable difference, and resale between customers is (naturally or made) difficult

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

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

  5. Membership fee P Under uniform pricing: MR=MC=>Q*=3, P*=260 Perfect price discrimination =>membership fee: A+B+C Each meal’s price = $20 500 A 260 B C Socially optimal output 20 Q 3 6

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

  7. Third Degree Price Discrimination • 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 • If p= $30, only group 1 readers will buy the book. Arcadia obtains $30x100K =$3M (gross of loyalty) • If p= $5, both groups of readers will buy the book. Arcadia obtains $5x500K=$2.5M (gross of loyalty) • Hence, charging $30 is better.

  8. Price Discrimination • 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. • Price discrimination leads to • greater profits • greater social welfare!!

  9. Determination of differentiated prices under constant marginal cost

  10. Evidence of Geographic Price Discrimination • Parallel imports--unauthorized flows of genuine products across countries that compete with authorized distribution channels (ranging from deluxe cars to cheap beer) • 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.

  11. Price Discrimination: How to separate different customers • 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 • 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). • Educational edition--software companies charge a substantial lower price to teachers and students for their software

  12. Price Discrimination: How to separate different customers • 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 • 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

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