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Price Discrimination Overheads. Price discrimination is the selling of two varieties of a product to two different buyers at different net prices , where the net price is the price paid by the buyer, adjusted for any cost of product differentiation.

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Presentation Transcript
slide2

Price discrimination is the selling of two varieties of

a product to two different buyers at different net

prices, where the net price is the price paid by the

buyer, adjusted for any cost of product differentiation

Price discrimination occurs when a firm charges

different prices to different customers for reasons

other than differences in production costs

slide3

Requirements for Price Discrimination

There must be a downwards sloping

demand curve for the firm's output

The firm must be able to raise price

without losing all its customers

slide4

The firm must be able to identify consumers

who are willing to pay more for the product

The firm must know who will pay the higher price

Auctions

Airlines

slide5

The firm must be able to prevent low-price

customers from reselling to high-price customers

Arbitrage is the purchase of products at a

low price in order sell them at a high price

slide6

Ways to identify customers

long term relationships

insurance agent

jeweler

doctor

age

sex

type of job

other commonly bought items

place of residence

slide7

Prevention of Arbitrage

Customer specific products

haircuts

house plans

dental filling

gall bladder operation

slide8

Use of product predicated on specific characteristics

student discount card

senior citizen discount

air travel with weekend stay

summer use of condominium at ski resort

slide9

Product is hard to resell because of distance

or transactions costs

purchase of corn silage

purchase of feeder cattle

purchase of custom made shoes

slide10

First-degree (perfect) price discrimination

A firm practices first-degree

or perfect price discrimination

if it is able to charge the maximum price

each consumer is willing to pay for each unit sold

Specifically, perfect price discrimination involves the seller

charging a different price for each unit of the good

in such a way that the price charged for each unit is equal

to the maximum willingness to pay for that unit

slide11

Example of Grandpa Jones

5 Spoker D tractors

Marginal value of zero to Grandpa Jones

2 identical interested buyers

slide12

Value (demand) schedule for each buyer

Tractors Price

First $16,000

Second $12,000

Third $8,000

Fourth $6,000

Fifth $4,000

slide13

Price and Demand

$

16

14

12

10

8

6

4

2

1

2

3

4

5

6

7

8

9

10

Tractors

slide14

Uniform pricing

Price (Demand) Total

Revenue

> $16,000 0 0

$16,000 1 16,000

$16,000 2 32,000

$12,000 3 36,000

$12,000 4 48,000

$8,000 5 40,000

$8,000 6 48,000

$6,000 7 42,000

$6,000 8 48,000

$4,000 9 36,000

$4,000 10 40,000

slide16

Can Grandpa Jones do better?

How about $12,000 a piece for 4 tractors?

Total revenue = $48,000

slide17

Grandpa Jones ends up with a tractor

of no value to him

An individual willing to pay $8,000

for a tractor is shut out of the market

But revenue is higher than when selling

all 5 at a uniform price of $8,000

slide18

First Degree Price Discrimination

Charge the maximum price

each consumer is willing to pay

for each unit sold

slide19

First Degree Price Discrimination

Sell the first tractor for $16,000

Sell the second tractor for $16,000

Sell the third tractor for $12,000

Sell the fourth tractor for $12,000

Sell the fifth tractor for $8,000

Total Revenue = $64,000

slide20

How does Grandpa Jones do it?

Offer a bundle of two tractors for $28,000

Each consumer will buy one bundle

Total revenue is $56,000

$48,000 < $56,000 < $64,000

slide21

Even better

Offer a bundle of two tractors for $28,000

With an option to bid on a third

Or an option to buy a third for $8,000

Each consumer will buy one bundle

The auction for the remaining tractor will yield $8,000

Total revenue = $64,000

slide22

Another way

Offer a three unit bundle for $36,000

Either one guy buys or the other guy buys and Grandpa Jones is left with two tractors

Offer a two unit bundle for $28,000

Either one guy buys or the other guy buys and Grandpa Jones is left with no tractors

Total profit = $64,000

slide23

Why not offer all five units

Offer a bundle of five tractors for $46,000

One buyer will purchase all five of them

All the tractors are gone and Grandpa Jones’s profits are only $46,000

slide24

But first buyer can then sell two tractors for $28,000 to the other buyer

First buyer has profits of $18,000

Total profits are $64,000

But poor Grandpa only gets $46,000 of them

slide25

A simple example of discriminating monopolist

p = 20 - 2Q

Q = 10 - 1/2p

Cost = MC = $4.00

slide27

TR MR MC Profit

Q Price UNF UNF Cost Exact

0 20 0 --- 0 4 0.00

1 18 18 18 4 4 14.00

2 16 32 14 8 4 24.00

3 14 42 10 12 4 30.00

4 12 48 6 16 4 32.00

5 10 50 2 20 4 30.00

6 8 48 -2 24 4 24.00

7 6 42 -6 28 4 14.00

8 4 32 -1 32 4 0.00

9 2 18 -1 36 4 -18.00

10 0 0 -1 40 4 -40.00

slide28

22

$

20

18

Price

Profit

16

MR

14

12

MC

10

PU

Revenue

8

QU

6

4

2

0

0

1

2

3

4

5

6

7

8

9

10

11

12

Output

Profit Max for Uniform Price Monopolist

Cost

slide29

Results

Uniform Price Monopolist

Q = 4

TR = 48

TC = 16

Profit = 32

slide30

Now consider a price discriminating monopolist

Each unit receives a different price

slide31

MC TR MR Profit

Q Price Cost Exact DSC DSC DSC

0 20 0 4 0.00 0

1 18 4 4 18.00 18 14.00

2 16 8 4 34.00 16 26.00

3 14 12 4 48.00 14 36.00

4 12 16 4 60.00 12 44.00

5 10 20 4 70.00 10 50.00

6 8 24 4 78.00 8 54.00

7 6 28 4 84.00 6 56.00

8 4 32 4 88.00 4 56.00

9 2 36 4 90.00 2 54.00

10 0 40 4 90.00 0 50.00

slide32

22

$

20

18

Price

16

MR

14

12

MC

10

PU

8

QU

6

4

2

0

0

1

2

3

4

5

6

7

8

9

10

11

12

Output

Profit Max for Discriminating Monopolist

slide33

22

$

20

18

Price

16

14

12

MC

10

PU

8

QU

6

4

2

0

0

1

2

3

4

5

6

7

8

9

10

11

12

Output

Profit Max for Discriminating Monopolist

slide34

Discriminating

Monopolist

Uniform Price

Monopolist

Results

Q = 8

Q = 4

TR = 88

TR = 48

TC = 32

TC = 16

Profit = 56

Profit = 32

slide35

Monopoly and Competition

The perfectly discriminating monopolist

will produce the same amount as a

competitive industry with the same cost structure

slide36

Consumers much prefer competition

They pay much less for the same quantity

slide37

22

$

20

18

Price

16

14

12

MC

10

8

6

4

Cost/ Revenue

2

0

0

1

2

3

4

5

6

7

8

9

10

11

12

Output

Competitive Equilibrium

slide38

Non-integer quantities (sales)

If the monopolist can charge for and sell

partial quantities, then the maximum that

can be charged is

the total area under the demand curve

to the left of a given quantity

slide39

22

$

20

18

Price

16

14

12

MC

10

8

6

4

2

0

0

1

2

3

4

5

6

7

8

9

10

11

12

Output

Profit Max for Discriminating Monopolist

Profit

Cost

slide40

Results

Perfectly

Discriminating

Monopolist

Discriminating

Monopolist

Q = 8

Q = 8

TR = 96

TR = 88

TC = 32

TC = 32

Profit = 64

Profit = 56

slide41

Segregating Markets

Identify Consumers

Prevent Arbitrage

Airline Example

slide42

Profit

MC

E

Demand

H

MR

Uniform Price Monopoly

Total Profit = $1200

$

160

120

Revenue

100

80

Cost

0

0

10

30

40

Number of Round-trip

Tickets

slide43

Gain

Profit

MC

E

Demand

H

AC

MR

Charge $160 for No Restriction Ticket

Total Profit = $1600

$

160

120

100

Revenue

80

Cost

0

0

10

30

40

Number of Round-trip

Tickets

slide44

MC

P > MC

Demand

H

MR

Charge $100 for Student Tickets

$

160

120

100

80

0

0

10

30

40

Number of Round-trip

Tickets

slide45

MC

P > MC

Demand

Charge $100 for Student Tickets

$

160

120

100

80

0

0

10

30

40

Number of Round-trip

Tickets

slide46

MC

P > MC

Demand

Charge $100 for Student Tickets

$

160

120

100

80

0

0

10

30

40

Number of Round-trip

Tickets

slide47

MC

Additional Revenue

Demand

Additional Cost

Charge $100 for Student Tickets

$

160

120

100

80

0

0

10

30

40

Number of Round-trip

Tickets

slide48

MC

Additional Profit

Demand

H

Additional Cost

Charge $100 for Student Tickets

$

160

120

100

80

0

0

10

30

40

Number of Round-trip

Tickets

slide49

Gain

MC

Demand

H

Overall Gain from Price Discrimination

$

160

120

100

80

0

0

10

30

40

Number of Round-trip

Tickets

slide51

MC TR MR Profit

Q Price Cost Exact DSC DSC DSC

0 20 0 4 0

1 18 4 4 18.00 18 14.00

2 16 8 4 34.00 16 26.00

3 14 12 4 48.00 14 36.00

4 12 16 4 60.00 12 44.00

5 10 20 4 70.00 10 50.00

6 8 24 4 78.00 8 54.00

7 6 28 4 84.00 6 56.00

8 4 32 4 88.00 4 56.00

9 2 36 4 90.00 2 54.00

10 0 40 4 90.00 0 50.00

slide52

TR MR Profit MR TR MR Profit

Q Price UNF UNF Cost MC UNF DSC DSC DSC

0 20 0 0 4 0.00 20.00 0

1 18 18 18 4 4 14.00 16.00 18.00 18 14.00

2 16 32 14 8 4 24.00 12.00 34.00 16 26.00

3 14 42 10 12 4 30.00 8.00 48.00 14 36.00

4 12 48 6 16 4 32.00 4.00 60.00 12 44.00

5 10 50 2 20 4 30.00 0.00 70.00 10 50.00

6 8 48 -2 24 4 24.00 -4.00 78.00 8 54.00

7 6 42 -6 28 4 14.00 -8.00 84.00 6 56.00

8 4 32 -1 32 4 0.00 -12.00 88.00 4 56.00

9 2 18 -1 36 4 -18.00 -16.00 90.00 2 54.00

10 0 0 -1 40 4 -40.00 -20.00 90.00 0 50.00

slide53

$

160

E

120

F

G

100

80

H

0

0

10

30

40

Number of Round-trip

Tickets