Title: The practice of charging unequal prices or fees to different buyers or classes of buyers is called p
1 Price discrimination The practice of charging unequal prices or fees to different buyers (or classes of buyers) is called price discrimination 2 Examples of price discrimination
Physicians charge more for an office visit if the patient has health insurance.
Magazines such as Sports Illustrated offer gifts and discounts to new subscribers.
Senior citizens may enjoy discounted rates at motels and restaurants.
Cinemas charge higher ticket prices for adults than for kids.
Japanese steel and Canadian timber producers earn sharply lower profit margins on products sold in the U.S. compared to the domestic market.
Sizing up their income pricing by plumbers auto mechanics . . .
A Mercedes driver can pay more so why not charge them more 4 When is price discrimination feasible
Price-discrimination (PD) can be a very lucrative proposition from the sellers point of view. However PD will not be feasible or possible unless
The seller possesses market powermeaning the seller faces a downward sloping demand curve.
The seller is capable of segregating buyers into groups based on differential willingness to pay or elasticity of demand (). Hear audio explanation (wav).
The seller can prevent arbitrage or resale of the product. Her audio explanation (wav)
5 1st Degree Price Discrimination This is referred to as perfect PD. The seller charges every buyer their reservation pricethat is the maximum price they are willing to pay rather then go without the marginal unit of the good or service 6
Perfectly discriminating monopolist charges PC for the last unit only.
Market output is equal to the competitive output (QC)
Total Surplus (TS) is equal to green shaded area APCB
Price A B PC MC D MR 0 QM QC Quantity Hear audio explanation (wav) 7 3rd degree price discrimination the welfare effects
To illustrate these effects we use the example of Kevlar du Ponts patented super-strength synthetic fiber.
We assume there are two uses for Kevlar
8 Differential elasticities of demand ()
Steel and fiberglass are good substitutes for Kevlar in tire production where there are no good substitutes for Kevlar in the manufacture of undersea cable.
Let t denote the elasticity of demand for Kevlar on the part of tire makers.
c is the elasticity of demand for Kevlar for use in production of undersea cables.
t C 1 9 Symbols assumptions
Pc Price per unit of Kevlar charged to cable manufactures
Pt Price per unit of Kevlar charged to tire manufacturers
qc Quantity of Kevlar purchased by cable manufacturers
qt Quantity of Kevlar purchased by tire manufacturers.
We assume that MC ATC 20.
The demand functions are given by qC 100 - Pc
qt 60 - Pt
10 Price Audio explanation (wav) Price discriminating firm sets MR MC in each submarket D cable W 60 D cable tires H 50 F N MRC 40 D tires MC C J 20 A S MRt MRC t 20 0 10 40 60 50 Tires Cable 11 2 scenarios
Standard monopoly pricing (single price)
PC Pt 50
Q qC qt 50 10 60 units
TR TC (50)(60) (60)(20) 1800
3rd degree price discrimination
PC 60 Pt 40 audio explanation (wav)
Q qC qt 40 20 60 Units
TR TC (60)(40) (40)(20) (60)(20) 2000
12 So du Pont can increase its profits by 200 (from 1800 to 2000) by practicing price discrimination 13 The welfare effects
As a consequence of P.D. cable manufacturers pay 60 per unit instead of 50. This gives rise to a welfare loss of WFSA or 350.
If du Pont discriminates then tire manufacturers pay a lower price than they otherwise would (40 instead of 50). This gives rise to a welfare gain of NHGJ or 250.
TS WFSA NHGJ -250
14 Moral of the story By enforcing statutes applicable to price discrimination (specifically section 2 of the Clayton Act) the total surplus could be potentially increased by 250.
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