Lecture 15, Chapter 13 Price Discrimination and Perfect Price Discrimination.
Price Discrimination Overheads
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Price Discrimination Overheads
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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. - PowerPoint PPT Presentation
Transcript of Price Discrimination Overheads
Price Discrimination
Overheads
Price discrimination is the selling of two varieties ofa product to two different buyers at different netprices, where the net price is the price paid by thebuyer, adjusted for any cost of product differentiation
Price discrimination occurs when a firm chargesdifferent prices to different customers for reasonsother than differences in production costs
Requirements for Price Discrimination
There must be a downwards slopingdemand curve for the firm's output
The firm must be able to raise pricewithout losing all its customers
The firm must be able to identify consumerswho are willing to pay more for the product
The firm must know who will pay the higher price
Auctions
Airlines
The firm must be able to prevent low-pricecustomers from reselling to high-price customers
Arbitrage is the purchase of products at alow price in order sell them at a high price
Ways to identify customerslong term relationships
age
sex
type of job
other commonly bought items
place of residence
insurance agent
jeweler
doctor
Prevention of Arbitrage
Customer specific products
haircuts
house plans
dental filling
gall bladder operation
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
Product is hard to resell because of distanceor transactions costs
purchase of feeder cattle
purchase of corn silage
purchase of custom made shoes
First-degree (perfect) price discrimination
A firm practices first-degree or perfect price discrimination
Specifically, perfect price discrimination involves the sellercharging a different price for each unit of the goodin such a way that the price charged for each unit is equalto the maximum willingness to pay for that unit
if it is able to charge the maximum priceeach consumer is willing to pay for each unit sold
Example of Grandpa Jones
5 Spoker D tractors
Marginal value of zero to Grandpa Jones
2 identical interested buyers
Tractors Price
First $16,000Second $12,000
Third $8,000
Fourth $6,000Fifth $4,000
Value (demand) schedule for each buyer
$
Tractors2 4 6 8 101 3 5 7 9
2468
10121416
Price and Demand
Price (Demand) Total Revenue
> $16,000 0 0
$12,000 3 36,000$16,000 2 32,000
$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
$16,000 1 16,000
Uniform pricing
$4,000 10 40,000
To sell all 5 tractors the uniform price must be
$8,000
Total revenue = $40,000
Can Grandpa Jones do better?
How about $12,000 a piece for 4 tractors?
Total revenue = $48,000
Grandpa Jones ends up with a tractorof 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 sellingall 5 at a uniform price of $8,000
First Degree Price Discrimination
Charge the maximum priceeach consumer is willing to payfor each unit sold
Sell the first tractor for $16,000
First Degree Price Discrimination
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
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
Offer a bundle of two tractors for $28,000
Even better
With an option to bid on a third
Each consumer will buy one bundle
The auction for the remaining tractor will yield $8,000
Total revenue = $64,000
Or an option to buy a third for $8,000
Either one guy buys or the other guy buys and Grandpa Jones is left with two tractors
Offer a three unit bundle for $36,000
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
Another way
Offer a bundle of five tractors for $46,000
Why not offer all five units
One buyer will purchase all five of them
All the tractors are gone and Grandpa Jones’s profits are only $46,000
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
A simple example of discriminating monopolist
p = 20 - 2Q
Q = 10 - 1/2p
Cost = MC = $4.00
Uniform pricing first
TR MR MC ProfitQ Price UNF UNF Cost Exact
1 18 18 18 4 4 14.002 16 32 14 8 4 24.003 14 42 10 12 4 30.004 12 48 6 16 4 32.005 10 50 2 20 4 30.006 8 48 -2 24 4 24.007 6 42 -6 28 4 14.008 4 32 -1 32 4 0.009 2 18 -1 36 4 -18.0010 0 0 -1 40 4 -40.00
0 20 0 --- 0 4 0.00
Revenue
Profit Max for Uniform Price Monopolist
0
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0 1 2 3 4 5 6 7 8 9 10 11 12
Output
$
Price
MR
MC
PU
QU
Cost
Profit
ResultsUniform Price Monopolist
Q = 4
TR = 48
TC = 16
Profit = 32
Now consider a price discriminating monopolist
Each unit receives a different price
MC TR MR ProfitQ Price Cost Exact DSC DSC DSC0 20 0 4 0.00 01 18 4 4 18.00 18 14.002 16 8 4 34.00 16 26.003 14 12 4 48.00 14 36.004 12 16 4 60.00 12 44.005 10 20 4 70.00 10 50.006 8 24 4 78.00 8 54.007 6 28 4 84.00 6 56.008 4 32 4 88.00 4 56.00
9 2 36 4 90.00 2 54.0010 0 40 4 90.00 0 50.00
Profit Max for Discriminating Monopolist
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0 1 2 3 4 5 6 7 8 9 10 11 12
Output
$
Price
MR
PU
QU
MC
Profit Max for Discriminating Monopolist
0
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0 1 2 3 4 5 6 7 8 9 10 11 12
Output
$
Price
PU
QU
MC
Q = 8
TR = 88
TC = 32
Profit = 56
DiscriminatingMonopolist
Uniform PriceMonopolist
Q = 4
TR = 48
TC = 16
Profit = 32
Results
Monopoly and Competition
The perfectly discriminating monopolistwill produce the same amount as acompetitive industry with the same cost structure
Consumers much prefer competition
They pay much less for the same quantity
Competitive Equilibrium
0
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0 1 2 3 4 5 6 7 8 9 10 11 12
Output
$
Price
MC
Cost/ Revenue
Non-integer quantities (sales)
If the monopolist can charge for and sellpartial quantities, then the maximum thatcan be charged is
the total area under the demand curveto the left of a given quantity
Profit Max for Discriminating Monopolist
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0 1 2 3 4 5 6 7 8 9 10 11 12
Output
$
Price
MC
Cost
Profit
DiscriminatingMonopolist
Q = 8
TR = 88
TC = 32
Profit = 56
PerfectlyDiscriminatingMonopolist
Q = 8
TR = 96
TC = 32
Profit = 64
Results
Segregating Markets
Identify Consumers
Prevent Arbitrage
Airline Example
0
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160
0 10 30 40
Number of Round-tripTickets
$
Demand
MR
MC
H
E
Revenue
Cost
Profit
Uniform Price Monopoly
Total Profit = $1200
0
80
100
120
160
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Number of Round-tripTickets
$
Demand
MR
MC
H
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Charge $160 for No Restriction Ticket
ProfitGain Total Profit = $1600
AC
Revenue
Cost
0
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Number of Round-tripTickets
$
Demand
MR
MC
H
Charge $100 for Student Tickets
P > MC
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Number of Round-tripTickets
$
Demand
MC
Charge $100 for Student Tickets
P > MC
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160
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Number of Round-tripTickets
$
Demand
MC
Charge $100 for Student Tickets
P > MC
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Number of Round-tripTickets
$
Demand
Charge $100 for Student Tickets
MC
Additional Cost
Additional Revenue
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Number of Round-tripTickets
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DemandH
Charge $100 for Student Tickets
MC
Additional Cost
Additional Profit
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Number of Round-tripTickets
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DemandH
Overall Gain from Price Discrimination
GainMC
The End
MC TR MR ProfitQ Price Cost Exact DSC DSC DSC0 20 0 4 01 18 4 4 18.00 18 14.002 16 8 4 34.00 16 26.003 14 12 4 48.00 14 36.004 12 16 4 60.00 12 44.005 10 20 4 70.00 10 50.006 8 24 4 78.00 8 54.007 6 28 4 84.00 6 56.008 4 32 4 88.00 4 56.009 2 36 4 90.00 2 54.0010 0 40 4 90.00 0 50.00
TR MR Profit MR TR MR ProfitQ Price UNF UNF Cost MC UNF DSC DSC DSC
0 20 0 0 4 0.00 20.00 01 18 18 18 4 4 14.00 16.00 18.00 18 14.002 16 32 14 8 4 24.00 12.00 34.00 16 26.003 14 42 10 12 4 30.00 8.00 48.00 14 36.004 12 48 6 16 4 32.00 4.00 60.00 12 44.005 10 50 2 20 4 30.00 0.00 70.00 10 50.006 8 48 -2 24 4 24.00 -4.00 78.00 8 54.007 6 42 -6 28 4 14.00 -8.00 84.00 6 56.008 4 32 -1 32 4 0.00 -12.00 88.00 4 56.009 2 18 -1 36 4 -18.00 -16.00 90.00 2 54.0010 0 0 -1 40 4 -40.00 -20.00 90.00 0 50.00
0
80
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0 10 30 40Number of Round-tripTickets
$
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