Price Discrimination. What is Price Discrimination? Single-price monopolist are ones that charge all...

Price DiscriminationPrice Discrimination

What is Price Discrimination?What is Price Discrimination?

• Single-price monopolist are ones that Single-price monopolist are ones that charge all consumers the same pricecharge all consumers the same price

• BUT….not all monopolist do this!BUT….not all monopolist do this!

• Price Discrimination is when sellers charge Price Discrimination is when sellers charge different prices to different consumers for different prices to different consumers for the same goodthe same good


• What is something we encounter regularly?What is something we encounter regularly?

Airline TicketsAirline Tickets

• There are lots of airlines but most routes in the There are lots of airlines but most routes in the US (or any country/area) are serviced by one or US (or any country/area) are serviced by one or two carrierstwo carriers

• Passengers regularly ask….”how much will it Passengers regularly ask….”how much will it cost me to fly there?”cost me to fly there?”


• Although….airlines are usually an Although….airlines are usually an oligopolyoligopoly

• Price discrimination does take place Price discrimination does take place under oligopolies and monopolistic under oligopolies and monopolistic competition and monopoliescompetition and monopolies

• Does not happen under perfect Does not happen under perfect competitioncompetition

Definition of Price DiscriminationDefinition of Price Discrimination

• Selling same product at different prices Selling same product at different prices to different customers in order to to different customers in order to increase profitincrease profit

• Profit-maximization quantity if found Profit-maximization quantity if found where where MR = MCMR = MC

• The profit-maximizing price is the highest The profit-maximizing price is the highest price that customers will pay to purchase price that customers will pay to purchase a good or servicea good or service

Principles of Price DiscriminationPrinciples of Price Discrimination

• First Principle:First Principle:1.1. If the demand curves are different, it is If the demand curves are different, it is

more profitable to set different prices in more profitable to set different prices in different markets than a single price that different markets than a single price that covers all marketscovers all markets

• GSK and their drug Combivir (HIV)GSK and their drug Combivir (HIV)


• First Principle Part A:First Principle Part A:1. a. To maximize profit the firm should set a 1. a. To maximize profit the firm should set a

higher price in markets with more higher price in markets with more inelastic demand inelastic demand

• Why?Why?• GSK wants to set a higher price for Combivir in GSK wants to set a higher price for Combivir in

Europe than in Africa but we know that setting Europe than in Africa but we know that setting two different prices leads to smuggling and this two different prices leads to smuggling and this means fewer sales for GSKmeans fewer sales for GSK


• If smuggling is large-scale, GSK will end up If smuggling is large-scale, GSK will end up selling more of its output at Africa which is selling more of its output at Africa which is less profitable than if GSK set a single world less profitable than if GSK set a single world priceprice

• What should GSK do (or could do)? What should GSK do (or could do)?

• If the smugglers can’t be stopped, GSK will If the smugglers can’t be stopped, GSK will abandon price discrimination and set a single abandon price discrimination and set a single world priceworld price


• Arbitrage is taking advantage of price Arbitrage is taking advantage of price differences for the same good in differences for the same good in different market by buying low in one different market by buying low in one market and selling high in another market and selling high in another marketmarket

• Legal term that is applied to special Legal term that is applied to special examples of smugglingexamples of smuggling


• The first principle explains that a firm The first principle explains that a firm WANTSWANTS to set different prices in different marketto set different prices in different market

• The second principle tells us that a firm may The second principle tells us that a firm may not be not be ABLEABLE to set different prices in to set different prices in different marketsdifferent markets

• How can a firm be successful at price How can a firm be successful at price discrimination?discrimination?

• The monopolist The monopolist MUST MUST prevent arbitrage!prevent arbitrage!


• How can a monopolist prevent arbitrage?How can a monopolist prevent arbitrage?• Examples:Examples:– GSK can color code the pills, Red for Europe, GSK can color code the pills, Red for Europe,

Blue for AfricaBlue for Africa– GSK can use special bar codes on each GSK can use special bar codes on each

package and can track the distributorspackage and can track the distributors– DVDs have region codes that prevent DVDs DVDs have region codes that prevent DVDs

bought in India being played in US playersbought in India being played in US players


• Second Principle of Price Discrimination:Second Principle of Price Discrimination:– Arbitrage makes it difficult for a firm to set Arbitrage makes it difficult for a firm to set

different prices in different markets, thereby different prices in different markets, thereby reducing the profit from price discriminationreducing the profit from price discrimination

• Example:Example:–Government taxes alcohol but subsidizes Government taxes alcohol but subsidizes

ethanol fuel to prevent arbitrageethanol fuel to prevent arbitrage– Services are difficult to arbitrageServices are difficult to arbitrage

Examples of Price DiscriminationExamples 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 Why? Child Prices (younger people) have more

inelastic demand inelastic demand

• Airlines (business travel verse vacationing)Airlines (business travel verse vacationing)– Businessmen are less sensitive to the price of an Businessmen are less sensitive to the price of an

airline ticket than vacationersairline ticket than vacationers– How determine? Vacationers buy tickets in How determine? Vacationers buy tickets in

advance, businessmen do notadvance, businessmen do not


• Universities are the biggest practioners of Universities are the biggest practioners of price discriminationprice discrimination– Hidden under “Student Aid”Hidden under “Student Aid”– Charging different prices for the same goodCharging 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 & parentsDetermine by tax returns of students & parents

• Universities are the example of Perfect Price Universities are the example of Perfect Price DiscriminationDiscrimination

Perfect Price DiscriminationPerfect Price Discrimination• Perfect Price Discrimination is when each Perfect Price Discrimination is when each

customer is charges his/her maximum willingness customer is charges his/her maximum willingness to payto pay– If/when each person is charged their maximum If/when each person is charged their maximum

willingness to pay, consumers end up with AZERO willingness to pay, consumers end up with AZERO consumer surplus BUT it will not lead to deadweight consumer surplus BUT it will not lead to deadweight lossloss

Perfect Price DiscriminationPerfect Price Discrimination

• When a consumer’s willingness to pay is When a consumer’s willingness to pay is higher than marginal cost, then that higher than marginal cost, then that consumer is sold a unit of the good – but this consumer is sold a unit of the good – but this means that PPD monopolist produces the means that PPD monopolist produces the efficient quantityefficient quantity

• PPD monopolist produces until P = MC, just PPD monopolist produces until P = MC, just like a competitive firmlike a competitive firm


• Remember ALL firms want to produce Remember ALL firms want to produce until MR = MCuntil MR = MC– Competitive Firm → MR = PCompetitive Firm → MR = P

– Competitive Firm produces until P = MCCompetitive Firm produces until P = MC

– Single-Price Monopolist → MR < P, Single-Price Monopolist → MR < P, produces less than a firmproduces less than a firm


• What is MR for a PPD monopolist?What is MR for a PPD monopolist?

PricePrice• Thus the PPD monopolist also sets P = MCThus the PPD monopolist also sets P = MC– Only done through detailed informationOnly done through detailed information– Ex. Retailers asking for your zip code, information = Ex. Retailers asking for your zip code, information =

profitprofit

• Is Price Discrimination Bad?Is Price Discrimination Bad?– PPM producers more output than a single-price PPM producers more output than a single-price

monopolist, so price discrimination can’t be bad?monopolist, so price discrimination can’t be bad?


• Although….what if Price Discrimination Although….what if Price Discrimination is imperfect?is imperfect?–Does a monopolist that sets 2 (or more) Does a monopolist that sets 2 (or more)

prices raise or lower total surplus?prices raise or lower total surplus?– Price Discrimination is bad if the total Price Discrimination is bad if the total

output with PD falls or stays the same but output with PD falls or stays the same but if output increases, than total surplus will if output increases, than total surplus will increaseincrease


• Problem → GSK is forbidden from price Problem → GSK is forbidden from price discriminating so it sets one world price, discriminating so it sets one world price, what price would GSK set? what price would GSK set?

• Would this increase or decrease total Would this increase or decrease total surplus?surplus?

Perfect Price DiscriminationPerfect Price Discrimination• GSK could lower the price so Africans can buy GSK could lower the price so Africans can buy

the drug easily Pworldthe drug easily Pworld• Single-price of PSingle-price of Pworldworld is better for Europe (P is better for Europe (Pworldworld < <

PPEuropeEurope) but worse for Africans since P) but worse for Africans since Pworldworld > P > PAfricaAfrica

– Depending on how much better off Europeans are Depending on how much better off Europeans are and how much worse off Africans are at Pand how much worse off Africans are at Pworldworld

– Price discrimination could be better or worsePrice discrimination could be better or worse– But….GSK would most likely not lower PBut….GSK would most likely not lower Pworld world too too

lowlow

Price Discrimination & Fixed CostPrice Discrimination & Fixed Cost• Profits increase with market sizeProfits increase with market size– Africans benefit from price discrimination with lower Africans benefit from price discrimination with lower

pricesprices– Europeans benefit from the price discrimination Europeans benefit from the price discrimination

increasing the profit from producing pharmaceuticals and increasing the profit from producing pharmaceuticals and more profit will mean more research and development more profit will mean more research and development and then more new drugs with equals a greater life and then more new drugs with equals a greater life expectancyexpectancy

• Higher fixed cost industries (airlines, chemicals, Higher fixed cost industries (airlines, chemicals, universities and software) tends to benefit from universities and software) tends to benefit from price discriminationprice discrimination

Other Price DiscriminationsOther Price Discriminations

• TYPINGTYPING – a form of price discrimination in – a form of price discrimination in which one good (base good) is tied to a second which one good (base good) is tied to a second good called a variable goodgood called a variable good

• Why are printers cheap but ink expensive?Why are printers cheap but ink expensive?– Profits come from inkProfits come from ink

• Ex. Xbox game consoles are priced below cost Ex. Xbox game consoles are priced below cost but Xbox games are priced above → cell but Xbox games are priced above → cell phones are priced below cost but phone calls phones are priced below cost but phone calls are priced aboveare priced above

Other Price DiscriminationsOther Price Discriminations• HP is selling a packaged goodHP is selling a packaged good– HP wants to charge a high price to consumers with a HP wants to charge a high price to consumers with a

high willingness to pay but a low price to consumers high willingness to pay but a low price to consumers with a low willingness to paywith a low willingness to pay

– Consumers with a high willingness probably want to Consumers with a high willingness probably want to print lots of color photos but consumers with a low print lots of color photos but consumers with a low willingness to pay will only print color photos willingness to pay will only print color photos occasionallyoccasionally

• Higher price for ink means HP is chagrining high Higher price for ink means HP is chagrining high willingness to pay consumers a high pricewillingness to pay consumers a high price


• HP, Xbox and Cell Phones show benefits HP, Xbox and Cell Phones show benefits and costs of price discriminationand costs of price discrimination– Price discrimination can increase output by Price discrimination can increase output by

lowering the price to users who only want lowering the price to users who only want to print occasional photosto print occasional photos–Due to this, fixed cost can be spread across Due to this, fixed cost can be spread across

research and developmentresearch and development


• ““BUNDLING” BUNDLING” – goods must be bought in a – goods must be bought in a packagepackage

• Bundling reduces costBundling reduces cost• This is a form of price discrimination, some This is a form of price discrimination, some

can take advantage and some don’tcan take advantage and some don’t• Microsoft Office verse Microsoft Word, Excel, Microsoft Office verse Microsoft Word, Excel,

etc.etc.– Bundling is cheaper than purchasing each program Bundling is cheaper than purchasing each program

separately if need two or more….separately if need two or more….

Overall/SummaryOverall/Summary• Price discrimination is same good to different Price discrimination is same good to different

customers at different pricescustomers at different prices• Firms price goods based on characteristics that are Firms price goods based on characteristics that are

correlated with willingness to paycorrelated with willingness to pay• Price discrimination requires firms to know about Price discrimination requires firms to know about

their consumertheir consumer• Price discrimination can increase total surplus – Price discrimination can increase total surplus –

increases total surplus when it increase output and increases total surplus when it increase output and when there are large fixed cost of developmentwhen there are large fixed cost of development

Price Discrimination NotesPrice Discrimination Notes

What is Price Discrimination?What is Price Discrimination?

• Single-price monopolist are ones that Single-price monopolist are ones that charge all consumers the same pricecharge all consumers the same price

• BUT….not all monopolist do this!BUT….not all monopolist do this!

• Price DiscriminationPrice Discrimination


• What is something we encounter regularly?What is something we encounter regularly?

• There are lots of airlines but most routes in There are lots of airlines but most routes in the US (or any country/area) are serviced by the US (or any country/area) are serviced by one or two carriersone or two carriers

• Passengers regularly ask….”how much will it Passengers regularly ask….”how much will it cost me to fly there?”cost me to fly there?”


• Although….airlines are usually an Although….airlines are usually an ______________________________

• Price discrimination does take place Price discrimination does take place under oligopolies and monopolistic under oligopolies and monopolistic competition and monopoliescompetition and monopolies

• Does not happen under Does not happen under __________________________________________

Definition of Price DiscriminationDefinition of Price Discrimination

• Selling same product at different prices Selling same product at different prices to different customers in order to to different customers in order to increase profitincrease profit

• Profit-maximization quantity if found Profit-maximization quantity if found where where ____________________________________________

• The profit-maximizing price is the The profit-maximizing price is the ______________price that customers will ______________price that customers will pay to purchase a good or servicepay to purchase a good or service


• First Principle:First Principle:1.1. If the demand curves are ____________, If the demand curves are ____________,

it is more ____________ to set different it is more ____________ to set different ____________ in different ____________ ____________ in different ____________ than a ____________price that covers all than a ____________price that covers all marketsmarkets

• GSK and their drug Combivir (HIV)GSK and their drug Combivir (HIV)


• First Principle Part A:First Principle Part A:1. a. To maximize profit the firm should set a 1. a. To maximize profit the firm should set a

_____ price in markets with more _____ price in markets with more ____________demand ____________demand

• Why?Why?• GSK wants to set a higher price for Combivir in GSK wants to set a higher price for Combivir in

Europe than in Africa but we know that setting Europe than in Africa but we know that setting two different prices leads to smuggling and this two different prices leads to smuggling and this means fewer sales for GSKmeans fewer sales for GSK


• If smuggling is large-scale, GSK will end up If smuggling is large-scale, GSK will end up selling more of its output at Africa which is selling more of its output at Africa which is less profitable than if GSK set a single world less profitable than if GSK set a single world priceprice

• What should GSK do (or could do)? What should GSK do (or could do)?


• ____________ is taking advantage of ____________ is taking advantage of price differences for the same good in price differences for the same good in different market by buying low in one different market by buying low in one market and selling high in another market and selling high in another marketmarket

• Legal term that is applied to special Legal term that is applied to special examples of ____________examples of ____________


• The first principle explains that a firm _______ The first principle explains that a firm _______ to set different prices in different marketto set different prices in different market

• The second principle tells us that a firm may The second principle tells us that a firm may not be _______ to set different prices in not be _______ to set different prices in different marketsdifferent markets

• How can a firm be successful at price How can a firm be successful at price discrimination?discrimination?

• The monopolist _______The monopolist _______ prevent arbitrage!prevent arbitrage!


• How can a monopolist prevent How can a monopolist prevent arbitrage?arbitrage?

• Examples:Examples:


• Second Principle of Price Discrimination:Second Principle of Price Discrimination:– Arbitrage makes it difficult for a firm to set Arbitrage makes it difficult for a firm to set

different _______ in different _______, different _______ in different _______, thereby reducing the _______ from price thereby reducing the _______ from price discriminationdiscrimination

• Example:Example:


• Price Discrimination is easy to see:Price Discrimination is easy to see:• _______ _______(senior vs. child prices)_______ _______(senior vs. child prices)– Why? Why?

• ______________ (business travel verse ______________ (business travel verse vacationing)vacationing)


• Universities are the biggest practioners of price Universities are the biggest practioners of price discriminationdiscrimination– Hidden under “______________”Hidden under “______________”– Charging different prices for the same goodCharging 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 DiscriminationPerfect Price Discrimination• Perfect Price Discrimination is when each Perfect Price Discrimination is when each

customer is charged his/her customer is charged his/her __________________________________________________– If/when each person is charged their maximum If/when each person is charged their maximum

willingness to pay, consumers end up with ______ willingness to pay, consumers end up with ______ consumer surplus BUT it will not lead to consumer surplus BUT it will not lead to ________________________________________________________


• When a consumer’s willingness to pay is When a consumer’s willingness to pay is higher than ______________, then that higher than ______________, then that consumer is sold a unit of the good – but this consumer is sold a unit of the good – but this means that PPD monopolist produces the means that PPD monopolist produces the ________________________________________________________

• PPD monopolist produces until PPD monopolist produces until ______________, just like a ______________ ______________, just like a ______________ firmfirm


• Remember ________ firms want to Remember ________ firms want to produce until ___________produce until ___________– Competitive Firm → ______________Competitive Firm → ______________

– Competitive Firm produces until ________Competitive Firm produces until ________

– Single-Price Monopolist → ___________, Single-Price Monopolist → ___________, produces less than a firmproduces less than a firm


• 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 informationOnly done through detailed information

• Is Price Discrimination Bad?Is Price Discrimination Bad?– PPM producers more output than a single-price PPM producers more output than a single-price

monopolist, so price discrimination can’t be bad?monopolist, so price discrimination can’t be bad?


• Although….what if Price Discrimination is Although….what if Price Discrimination is ______________?______________?– Does a monopolist that sets 2 (or more) Does a monopolist that sets 2 (or more)

prices, raise or lower total surplus?prices, raise or lower total surplus?– Price Discrimination is bad if the total Price Discrimination is bad if the total

__________ with price discrimination __________ with price discrimination _________or stays the same but if output _________or stays the same but if output __________, than ____________will __________, than ____________will increaseincrease


• Problem → GSK is forbidden from price Problem → GSK is forbidden from price discriminating so it sets one world price, discriminating so it sets one world price, what price would GSK set? what price would GSK set?

• Would this increase or decrease total Would this increase or decrease total surplus?surplus?

Perfect Price DiscriminationPerfect Price Discrimination• GSK could lower the price so Africans can buy GSK could lower the price so Africans can buy

the drug easily Pthe drug easily Pworldworld

• Single-price of PSingle-price of Pworldworld is better for Europe (P is better for Europe (Pworldworld < < PPEuropeEurope) but worse for Africans since P) but worse for Africans since Pworldworld > P > PAfricaAfrica

– Depending on how much better off Europeans are Depending on how much better off Europeans are and how much worse off Africans are at Pand how much worse off Africans are at Pworldworld

– Price discrimination could be better or worsePrice discrimination could be better or worse– But….GSK would most likely not lower PBut….GSK would most likely not lower Pworld world too too

lowlow

Price Discrimination & Fixed CostPrice Discrimination & Fixed Cost• Profits increase with ______________Profits increase with ______________– Africans benefit from price discrimination with Africans benefit from price discrimination with

____________________________________– Europeans benefit from the price discrimination Europeans benefit from the price discrimination

increasing the profit from producing pharmaceuticals and increasing the profit from producing pharmaceuticals and more profit will mean more _________ and _________ more profit will mean more _________ and _________ and then more new drugs with equals a greater and then more new drugs with equals a greater ____________________________________

• _________ fixed cost industries (airlines, chemicals, _________ fixed cost industries (airlines, chemicals, universities and software) tends to benefit from universities and software) tends to benefit from price discriminationprice discrimination


• __________________– a form of price __________________– a form of price discrimination in which one good (base good) discrimination in which one good (base good) is tied to a second good called a variable is tied to a second good called a variable goodgood

• Why are printers cheap but ink expensive?Why are printers cheap but ink expensive?

• Ex. Xbox game consoles are priced below cost but Ex. Xbox game consoles are priced below cost but Xbox games are priced above → cell phones are Xbox games are priced above → cell phones are priced below cost but phone calls are priced abovepriced below cost but phone calls are priced above

Other Price DiscriminationsOther Price Discriminations• HP is selling a packaged goodHP is selling a packaged good– HP wants to charge a high price to consumers with a HP wants to charge a high price to consumers with a

high willingness to pay but a low price to consumers high willingness to pay but a low price to consumers with a low willingness to paywith a low willingness to pay

– Consumers with a high willingness probably want to Consumers with a high willingness probably want to print lots of color photos but consumers with a low print lots of color photos but consumers with a low willingness to pay will only print color photos willingness to pay will only print color photos occasionallyoccasionally

• Higher price for ink means HP is charging high Higher price for ink means HP is charging high willingness to pay consumers a high pricewillingness to pay consumers a high price


• HP, Xbox and Cell Phones show benefits HP, Xbox and Cell Phones show benefits and costs of price discriminationand costs of price discrimination– Price discrimination can increase Price discrimination can increase

_________ by lowering the price to users _________ by lowering the price to users who only want to print occasional photoswho only want to print occasional photos

–Due to this, _________can be spread Due to this, _________can be spread across _________ and _________across _________ and _________


• __________________– goods must be bought __________________– goods must be bought in a packagein a package

• Bundling reduces _________Bundling reduces _________• This is a form of price discrimination, some This is a form of price discrimination, some

can take advantage and some don’tcan take advantage and some don’t• __________________verse _________, Excel, __________________verse _________, Excel,

etc.etc.– Bundling is cheaper than purchasing each program Bundling is cheaper than purchasing each program

separately if need two or more….separately if need two or more….

Overall/SummaryOverall/Summary• Price discrimination is same good to different Price discrimination is same good to different

customers at different pricescustomers at different prices• Firms price goods based on characteristics that are Firms price goods based on characteristics that are

correlated with ________________correlated with ________________• Price discrimination requires firms to Price discrimination requires firms to

____________________________________• Price discrimination can increase Price discrimination can increase

__________________– increases total surplus __________________– increases total surplus when it increase output and when there are large when it increase output and when there are large fixed cost of developmentfixed cost of development

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Price Discrimination. What is Price Discrimination? Single-price monopolist are ones that charge all...

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