ECONOMICS 3200M Lecture 13 March 8, 2005

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ECONOMICS 3200MLecture 13March 8, 2005
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Bayesian Analysis

• Incomplete information regarding state of demand,
  cost functions of rivals, strategic decisions of
  rivals
• Market interaction a game of asymmetric and
  incomplete information
• Firms history matters
• Conveys information to rivals
• Affects expectations of rivals
• Multi-period oligopolistic interactions
• Firms behaviour reveals information
• Rational for firm to manipulate rivals
  information and expectations

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Bayesian Analysis

• Bi , i 1 N (all possible events)
• A particular outcome
• P(Bi) a priori probabilities (expectations)
• Revise a priori probabilities after observing
  particular outcome
• P(BR?A) P(BR)P(A? BR)/?i1N P(Bi)P(A?
  Bi)
• Example
• N 2
• P(B1) 0.67 P(A? B1) 0.75 P(A? B2) 0.50
• A occurs
• P(B1?A) P(B1)P(A? B1)/?i1,2 P(Bi)P(A?
  Bi) 0.670.75/(0.670.75) (0.330.5)
  0.75

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Price Discrimination

• Sale of identical good/service at different
  prices to different buyers or at different prices
  to same buyer
• Alternative form of price discrimination
• Different bundles of features/characteristics and
  different prices
• Hotels suites, singles, doubles, floor level,
  other amenities (access to lounge, health clubs
  breakfast included priority check-in)
• First degree price discrimination perfect price
  discrimination
• Each unit sold at a different price extract all
  consumer surplus
• Difference between maximum price consumer willing
  to pay for product and actual price paid at each
  price for a particular product, each person that
  purchases the product gains a different value of
  consumer surplus different willingness to pay
  for a product
• Potential for market segmentation and price
  discrimination ? companies can exploit
  differences among consumers to increase their
  revenues and profits
• Auctions

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P
P1
P2
P3
Q
1
2
3
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P
Consumer surplus
P100
Total expenditures
Q
Q100
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Price Discrimination

• Third degree price discrimination
• Different prices to different groups of buyers
  (independent demands, interdependent cost model
  for monopolist)
• Prices differ on basis of signals related to
  perceived consumers preferences (age, location,
  occupation, income, ethnicity,etc.)
• Consumers on different demand curves as compared
  to first degree where consumers are at different
  positions on the same demand curve
• Movie theaters special rates for seniors,
  children
• Frequent user programs
• Wealth management
• Second degree
• Two-part tariffs fixed price (entry/membership
  fee) usage fee
• Preceding graph fixed price consumer surplus,
  and usage fee P100
• Membership in golf clubs
• Taxis
• Utilities

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Price Discrimination

• Conditions for price discrimination
• Firm must have some degree of market power
• Firm must be able to infer each consumers
  willingness to pay
• Firm must be able to prevent arbitrage

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Price Discrimination

• Arbitrage
• If transactions costs between consumers small
  relative to price of product, consumers who are
  able to pay low price buy extra quantities and
  re-sell to consumers who are willing to pay and
  are charged higher prices
• Scalping opportunity cost of time
• International price discrimination (dumping) and
  possibility for arbitrage transactions costs
  include transportation costs, tariffs, reputation
• Limit arbitrage
• Services cannot be resold entertainment
  services, telecom services exceptions
• Warranties valid only for original buyers
• Different bundles/prices
• Signals
• Vertical integration

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Price Discrimination

• Vertical integration example to prevent arbitrage
• Monopolist produces good used as input by two
  separate industries
• Elasticities of demand for input in 2 industries
  ?1 gt ?2
• P1 lt P2
• To prevent arbitrage
• Monopolist buys firm in industry 1 and sells only
  to this firm in this industry and sells to all
  firms in industry 2 at P2
• Other firms in industry 1 will be driven out of
  business

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Price Discrimination

• Third degree price discrimination
• Aggregate demand can be divided into N distinct
  segments on basis of exogenous information
  (signals reflecting consumer preferences, market
  research) different preferences reflected in
  different elasticities of demand
• Arbitrage not possible
• Example movie theaters different prices for
  children, youths, adults and seniors
• Pi MC/Pi 1/?i ? higher prices in markets
  with lower elasticities of demand
• Rule of thumb pricing P1/P2 (1 1/ ?2)/(1
  1/ ?1)
• Price discrimination may enable monopolist to
  survive example (MR1 MR2 MRN MC)

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Price Discrimination

• Third degree price discrimination
• Same delivered price for customers
• Freight absorption by producer
• Customers located farther from production/distribu
  tion (warehouse) facility may have alternative
  suppliers thus more elastic demand
• Other examples
• Monthly vs. hourly parking rates
• Metro Pass vs. single fare
• Frequent flyer/use programs
• Each consumer has downward sloping demand curve,
  thus willing to purchase more units per period of
  time only at lower per unit price
• Consumers have different demand curves

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Price Discrimination

• Price discrimination in intermediate products
  when large customer has bargaining advantage
• Large customer may be able to integrate upstream
  (internalize) implications for competition in
  downstream market
• Price discrimination (pi.e. price concessions)
  depends upon credibility of backward integration
• Bank loans large firms charged lower interest
  rates because they have direct access to
  commercial paper and bond markets

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Price Discrimination

• Second degree price discrimination
• Nonlinear pricing
• Different bundles peak-load pricing
• Two-part tariffs
• T(Q) A PQ, where A CS/N CS is aggregate
  consumer surplus, N is the total number of
  consumers with each one buying only one unit
• Examples membership for clubs electricity,
  water/sewer rates photocopier leases (fixed
  amount per month plus usage fee)
• With large numbers of consumers trade-off
  between entry fee and usage fees
• Large entry fee locks in consumers, reduces
  potential market but corresponding low usage fee
  makes entry less attractive ? consider what has
  happened to pricing for cell phones
• Multiple entry/usage fee combinations ? self
  selection by consumers

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Price Discrimination

• Second degree price discrimination
• Different bundles
• Inter-temporal pricing peak/off-peak pricing
• Product and time comprise bundle
• MC may differ between peak and off-peak periods
  thus not the same as 3rd degree price
  discrimination which assumes same MC for product
• Inter-temporal pricing fashion/technology
• Price decreases over time consumers who are
  impatient or fashion/status conscious willing to
  pay higher price than consumers who are patient
  or less fashion/status conscious
• If learning curve for producer MC declines over
  time so dissimilar from 3rd price discrimiantion