Price Discrimination

1
Price Discrimination

• Chapter 10.3

2
Price Discrimination

• A monopolist can benefits by charging different
  prices for identical items.
• Example-- Mrs. Lovetts Pies
• Set different price for different customer in the
  town.
• She can sell more pies than a true monopolist..
  In fact, her sales can be up to the competitive
  level
• This subtracts additional producers surplus than
  scenarios under monopoly.
• Social gain increases because of price
  discrimination.
• Note She can price differently only if she can
  prevent the low-priced units from being resold.

P
S
D
Q
3
First-degree price discrimination

• Charging each customer the most that he would be
  willing to pay for each item that he buys.

P
S
D
4
Second-degree price discrimination

• Quantity discountcharging the same customer
  different prices for identical items.
• E.g.
• buy one get one free

5
Price discrimination increases social welfare

• Price discrimination increases social output and
  social gains.
• the distribution of the increase in welfare
• First-degree price discrimination benefits the
  producers.
• Second-degree price discrimination benefits both
  consumers and producers.

6
Third-degree of price discrimination

• Charging different prices in different markets
• Mrs. Lovetts Pies
• Selling pies in two markets
• Local customers (monopoly)
• Big city (perfect competition)
• The marginal cost (opportunity cost) of selling
  one piece of pie in the hometown now equals 7
  (instead of the original MC line).
• She will produce Q1 pies altogether,
• Selling Q2 at home for 11 each
• Selling the rest (Q1-Q2) in the city for 7 each

P
MC
11
10
MRcity
7
D
MR
Q
Q2
Q1
Q0
7
The optimal production decision for the 3rd
degree discrimination

• Any producer selling in two different markets
  will choose quantities so that his marginal
  revenue is the same in each market.
• MR1 MR2 MC

• Other examples
• In-state students and out-of-state students
• CVS in Albany v.s. CVS in the NY City

8
Efficiency and the third-degree price
discrimination (omitted)
P
MC
A
B
11
10
C
D
E
G
DcityMRcity
F
H
I
7
L
M
J
K
D
MR
Q
Q2
Q1
Q0
9
Elasticity and the 3rd degree price
discrimination

• Consider a monopolist in two markets, suppose he
  charge P1 and P2 resp.
• Recall that the relation between price and
  marginal revenue is
• MR1P1(1-1/?1) and MR2P2(1-1/?2)
• Given the optimal condition
• MR1MR2MC
• he must have
• P1(1-1/?1)P2(1-1/?2)
• Thus,
• if ?1gt?2, then P1 ltP2.
• I.e. the group with the more elastic demand is
  charged the low price. In other words, a
  price-discriminating monopolist offers the lowest
  prices to the most price-sensitive customers.