Download Price Discrimination

Price Discrimination
What is Price Discrimination?
• Single-price monopolist are ones that
charge all consumers the same price
• BUT….not all monopolist do this!
• Price Discrimination is when sellers
charge different prices to different
consumers for the same good
Price Discrimination
• 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
• Passengers regularly ask….”how much will it cost
me to fly there?”
Price Discrimination
• Although….airlines are usually an
oligopoly
• Price discrimination does take place
under oligopolies and monopolistic
competition and monopolies
• Does not happen under perfect
competition
Definition of Price Discrimination
• Selling same product at different prices
to different customers in order to
increase profit
• 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
Principles of Price Discrimination
• 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)
Principles of Price Discrimination
• First Principle Part A:
1. a. To maximize profit the firm should set a
higher price in markets with more
inelastic demand
• 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
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
• 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
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
• 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 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?
• The monopolist MUST prevent arbitrage!
Principles of Price Discrimination
• How can a monopolist prevent
arbitrage?
• 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:
– Arbitrage makes it difficult for a firm to set
different prices in different markets,
thereby reducing the profit from price
discrimination
• 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:
• Movie theatres (senior vs. child prices)
– Why? Child Prices (younger people) have more
inelastic demand
• 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
– Hidden under “Student Aid”
– Charging different prices for the same good
• How are universities able to do this?
– Determine by tax returns of students & parents
• 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
– 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
• PPD monopolist produces until P = MC, just
like a competitive firm
Perfect Price Discrimination
• 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?
Price
• 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?
– 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?
– 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?
• Would this increase or decrease total
surplus?
Perfect Price Discrimination
• GSK could lower the price so Africans can buy
the drug easily Pworld
• Single-price of Pworld is better for Europe
(Pworld < PEurope) but worse for Africans since
Pworld > PAfrica
– Depending on how much better off Europeans
are and how much worse off Africans are at Pworld
– Price discrimination could be better or worse
– But….GSK would most likely not lower Pworld too
low
Price Discrimination & Fixed Cost
• 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
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
• 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
Other Price Discriminations
• 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
Other Price Discriminations
• 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 reduces cost
• This is a form of price discrimination, some
can take advantage and some don’t
• 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
• Firms price goods based on characteristics
that are correlated with willingness to pay
• 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 Notes
What is Price Discrimination?
• Single-price monopolist are ones that
charge all consumers the same price
• BUT….not all monopolist do this!
• Price Discrimination
Price Discrimination
• 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
• Passengers regularly ask….”how much will it
cost me to fly there?”
Price Discrimination
• Although….airlines are usually an
_______________
• Price discrimination does take place
under oligopolies and monopolistic
competition and monopolies
• Does not happen under
_____________________
Definition of Price Discrimination
• Selling same product at different prices
to different customers in order to
increase profit
• Profit-maximization quantity if found
where ______________________
• The profit-maximizing price is the
______________price that customers
will pay to purchase a good or service
Principles of Price Discrimination
• 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)
Principles of Price Discrimination
• First Principle Part A:
1. a. To maximize profit the firm should set a
_____ price in markets with more
____________demand
• 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
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
• 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
• 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 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?
• The monopolist _______ prevent arbitrage!
Principles of Price Discrimination
• How can a monopolist prevent
arbitrage?
• Examples:
Principles 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:
Examples of Price Discrimination
• Price Discrimination is easy to see:
• _______ _______(senior vs. child prices)
– Why?
• ______________ (business travel verse
vacationing)
Examples 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?
• Universities are the example of
____________________________
Perfect Price Discrimination
• 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
____________________________
• PPD monopolist produces until
______________, just like a ______________
firm
Perfect Price Discrimination
• 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?
• Thus the PPD monopolist also sets ________
– Only done through detailed information
• 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 ______________?
– 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?
• Would this increase or decrease total
surplus?
Perfect Price Discrimination
• GSK could lower the price so Africans can buy
the drug easily Pworld
• Single-price of Pworld is better for Europe
(Pworld < PEurope) but worse for Africans since
Pworld > PAfrica
– Depending on how much better off Europeans
are and how much worse off Africans are at Pworld
– Price discrimination could be better or worse
– But….GSK would most likely not lower Pworld too
low
Price Discrimination & Fixed Cost
• 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
Other Price Discriminations
• __________________– 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?
• 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 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
Other Price Discriminations
• 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
• Bundling reduces _________
• This is a form of price discrimination, some
can take advantage and some don’t
• __________________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
• Firms price goods based on characteristics
that are correlated with ________________
• 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