ch11.ppt price discrimination notes to learn
- 1. Chapter 11 Pricing with Market Power
- 2. Slide 2 Topics to be Discussed Capturing Consumer Surplus Price Discrimination Intertemporal Price Discrimination The Two-Part Tariff
- 3. Slide 3 Introduction Pricing without market power (perfect competition) is determined by market supply and demand. The individual producer must be able to forecast the market and then concentrate on managing production (cost) to maximize profits.
- 4. Slide 4 Introduction Pricing with market power (imperfect competition) requires the individual producer to know much more about the characteristics of demand as well as manage production.
- 5. Slide 5 Capturing Consumer Surplus Quantity $/Q D MR Pmax MC If price is raised above P*, the firm will lose sales and reduce profit. PC PC is the price that would exist in a perfectly competitive market. A P* Q* P1 Between 0 and Q*, consumers will pay more than P*--consumer surplus (A). B P2 Beyond Q*, price will have to fall to create a consumer surplus (B).
- 6. Slide 6 Capturing Consumer Surplus Price discrimination is the charging of different prices to different consumers for similar goods.
- 7. Slide 7 Price Discrimination First Degree Price Discrimination Charge a separate price to each customer: the maximum or reservation price they are willing to pay.
- 8. Slide 8 Question Why would a producer have difficulty in achieving first-degree price discrimination? Answer 1) Too many customers (impractical) 2) Could not estimate the reservation price for each customer Additional Profit From Perfect First- Degree Price Discrimination
- 9. Slide 9 Price Discrimination First Degree Price Discrimination The model does demonstrate the potential profit (incentive) of practicing price discrimination to some degree.
- 10. Slide 10 First-Degree Price Discrimination in Practice Quantity D MR MC $/Q P2 P3 P*4 P5 P6 P1 Six prices exist resulting in higher profits. With a single price P*4, there are fewer consumers and those who now pay P5 or P6 may have a surplus. Q
- 11. Slide 11 Second-degree price discrimination Practice of charging different prices per unit for different quantities of the same good or service.
- 12. Second-Degree Price Discrimination Quantity $/Q D MR MC AC P0 Q0 Without discrimination: P = P0 and Q = Q0. With second-degree discrimination there are three prices P1, P2, and P3. (e.g. electric utilities) P1 Q1 1st Block P2 Q2 P3 Q3 2nd Block 3rd Block Second-degree price discrimination is pricing according to quantity consumed--or in blocks.
- 13. Second-Degree Price Discrimination Quantity $/Q D MR MC AC P0 Q0 P1 Q1 1st Block P2 Q2 P3 Q3 2nd Block 3rd Block Economies of scale permit: •Increase consumer welfare •Higher profits
- 14. Slide 14 Price Discrimination Third Degree Price Discrimination 1) Divides the market into two or more groups. 2) Each group has its own demand function.
- 15. Slide 15 Price Discrimination Third Degree Price Discrimination 3) Most common type of price discrimination. Examples: airlines, liquor, vegetables, discounts to students and senior citizens.
- 16. Slide 16 Price Discrimination Third Degree Price Discrimination 4) Third-degree price discrimination is feasible when the seller can separate his/her market into groups who have different price elasticities of demand (e.g. business air travelers versus vacation air travelers)
- 17. Slide 17 Price Discrimination Third Degree Price Discrimination Objectives MR1 = MR2 MC1 = MR1 and MC2 = MR2 MR1 = MR2 = MC
- 18. Slide 18 Price Discrimination Third Degree Price Discrimination P1: price first group P2: price second group C(Qr) = total cost of QT = Q1 + Q2 Profit ( ) = P1Q1 + P2Q2 - C(Qr)
- 19. Slide 19 Price Discrimination Third Degree Price Discrimination Set incremental for sales to group 1 = 0 0 ( 1 1 ) 1 1 1 Q C Q Q P Q MC Q C MR Q Q P 1 1 1 1 1 ) (
- 20. Slide 20 Price Discrimination Third Degree Price Discrimination Second group of customers: MR2 = MC MR1 = MR2 = MC
- 21. Slide 21 Price Discrimination Third Degree Price Discrimination Determining relative prices ) 1 1 ( ) 1 1 ( 1 1 2 2 2 1 1 1 E P MR E P MR E P MR d : Then : Recall ) 1 1 ( ) 1 1 ( 1 2 2 1 E E P P : And
- 22. Slide 22 Price Discrimination Third Degree Price Discrimination Pricing: Charge higher price to group with a low demand elasticity
- 23. Slide 23 Price Discrimination Third Degree Price Discrimination Example: E1 = -2 & E2 = -4 P1 should be 1.5 times as high as P2 5 . 1 2 1 4 3 ) 2 1 1 ( ) 4 1 1 ( 2 1 P P
- 24. Slide 24 The Economics of Coupons and Rebates Those consumers who are more price elastic will tend to use the coupon/rebate more often when they purchase the product than those consumers with a less elastic demand. Coupons and rebate programs allow firms to price discriminate. Price Discrimination
- 25. Slide 25 Airline Fares Differences in elasticities imply that some customers will pay a higher fare than others. Business travelers have few choices and their demand is less elastic. Casual travelers have choices and are more price sensitive.
- 26. Slide 26 Elasticities of Demand for Air Travel Price -0.3 -0.4 -0.9 Income 1.2 1.2 1.8 Fare Category Elasticity First-Class Unrestricted Coach Discount
- 27. Slide 27 Airline Fares The airlines separate the market by setting various restrictions on the tickets. Less expensive: notice, stay over the weekend, no refund Most expensive: no restrictions
- 28. Slide 28 Example A monopolist is deciding how to allocate output between two markets. The two markets are separated geographically (East Coast and Midwest). P1=15-Q1 MR1=15-2Q1 P2=25-2Q2 MR2=25-4Q2 TC = 5+3(Q1+Q2) MC = 3. What are price, output, profits, marginal revenues, and deadweight loss if the monopolist can price discriminate?
- 29. Slide 29 Example 15 - 2Q1 = 3, or Q1 = 6. 25 - 4Q2 = 3, or Q2 = 5.5. P1 = 15 - 6 = $9 and P2 = 25 - 2(5.5) = $14. = ((6)(9) + (5.5)(14)) - (5 + 3X11.5) = $91.5. The monopoly deadweight loss in general is equal to DWL = (0.5)(QC - QM )(PM - PC ). DWL1 = (0.5)(12 - 6)(9 - 3) = $18 DWL2 = (0.5)(11 - 5.5)(14 - 3) = $30.25. Therefore, the total deadweight loss is $48.25.
- 30. Slide 30 Intertemporal Price Discrimination Separating the Market With Time Initial release of a product, the demand is inelastic Book Movie Computer
- 31. Slide 31 Separating the Market With Time Once this market has yielded a maximum profit, firms lower the price to appeal to a general market with a more elastic demand Paper back books Dollar Movies Discount computers Intertemporal Price Discrimination
- 32. Slide 32 The Two-Part Tariff The purchase of some products and services can be separated into two decisions, and therefore, two prices. An entry fee and a usage fee.
- 33. Slide 33 The Two-Part Tariff Examples 1) Amusement Park Pay to enter Pay for rides and food within the park 2) Tennis Club Pay to join Pay to play
- 34. Slide 34 The Two-Part Tariff Examples 3) Rental of Mainframe Computers Flat Fee Processing Time 4) Safety Razor Pay for razor Pay for blades
- 35. Slide 35 Question A monopolist supplies two markets: P1=10-Q1, MR1=10-2Q1 P2=30-3Q2, MR2=30-6Q2 MC=AC=6, TC=6(Q1+Q2) To maximize profit, P1 and P2?
- 36. Slide 36 Answer Q1=2, Q2=4. P1=8, P2=18.