The practice of charging unequal prices or fees to different buyers or classes of buyers is called p

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Price discrimination
The practice of charging unequal prices or fees
to different buyers (or classes of buyers) is
called price discrimination
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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.

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• Sizing up their income pricing by plumbers,
  auto mechanics, . . .

A Mercedes driver can pay more, so why not charge
them more?
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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)

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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
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• Notes
• 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)
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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
• Undersea cables
• Tires

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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.
• Thus

?t ?C 1
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Symbols, assumptions

• Let
• 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

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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
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2 scenarios

• Standard monopoly pricing (single price)
• PC Pt 50
• Q qC qt 50 10 60 units
• ? TR TC (50)(60) (60)(20) 1,800

• 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) 2,000

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So, du Pont can increase its profits by 200
(from 1,800 to 2,000) by practicing price
discrimination
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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.
• Thus,
• ?TS WFSA NHGJ -250

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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.