PRICE DISCRIMINATION WITH PRACTICAL EXAMPLES

Mohit Chhabra 101183012

Price discrimination• Price discrimination is an ability to charge different

prices for same product to different individuals or groups of individuals

• Price-discriminating monopoly does not discriminate based on stereotypes, or ill-will toward any person or group– Rather, it divides its customers into different categories

based on their willingness to pay for good

• Basic modelA. Same price for all units.B. Same price to all customers

Changing one or both of these is called Price Discrimination.

– 1st degree is different prices for both consumers and units (both A and B are changed)

– 2nd degree is different prices for different units (A changed).

– 3rd degree is different prices to different consumers (B changed).

Requirements for Price Discrimination

• To successfully price discriminate, three conditions must be satisfied– When producers have market power, i.e. Producer must

have price setting ability– Firm must be able to identify consumers willing to pay

more. i.e The firm must be able to “segment the market” to separate customers on differential willingness to pay, or elasticity of demand

– Firm must be able to prevent low-price customers from reselling to high-price customers

Various ways they can separate customers

Time – e.g. people travelling on trains at different times – those needing to get to work in the morning will have an inelastic demand compared to those going out shopping who can alter their time of travel

Age – children are charged a lower price at the cinema because their demand is more elastic having lower income

Gender – a football club in Sweden charges lower prices for female supporters than for male supporters (apparently they are not as keen and therefore have a more elastic demand)

Income – lawyers will often charge higher prices to wealthy clients who have a relatively inelastic demand for legal services

Geographical distance – this is only possible if the cost of transferring is greater than the difference in the price. E.g Hilly areas

Types of consumer – different users buy the service at different prices – electricity companies often charge different rates to industrial and domestic users

Three degrees of price discrimination

First degree price discrimination The seller charges every buyer their “reservation price”—

that is, the maximum price they are willing to pay Different prices for both consumers and units. This is referred to as “perfect” PD.• Traders bargain to get the highest price they can. E.g.

Trader selling world cup t-shirts to tourists in a market The trader bargains with each tourist If the trader is successful he will sell one shirt at $14, one at

$13, one and $12 and so on 1st degree captures the whole consumer surplus. Difficult to implement

Examples of 1st Degree Discrimination

• The bid and offer system in the housing market.

• Negotiating prices with dealers for second hand cars

• Dutch auctions• Antiques fairs and sales!

Second degree price discriminationA firm charge different prices to consumers

depending on how much they purchaseElectric and Gas companies do thisThey charge a high price for the first number of

units (the essential ones) and a lower price for extra units consumed

Mobile phone companies do the sameThe first 50 messages are charged at a rate of 30

cents each and any messages over this number are charged at a reduced rate of 20 cents

2nd degree Excess Capacity Pricing‐• Excess capacity pricing exists when sellers try to off load ‐

their spare output to buyers• Examples– Cheaper priced restaurant menus at lunchtime– Cinema tickets at morning– Hotels offering winter discounts– Car rental firms reducing prices at weekends• Not always the case that prices are lower if consumers delaytheir purchases– Advance discounts on season tickets for soccer clubs– Discounts for early booking of package holidays

– Peak demand (higher demand, less elastic)– Off peak demand (lower demand, more elastic)Peak demand occurs at predictable times during the day orseason– Higher price is charged at peak times to extract consumer

surplus , taking advantage of higher willingness to pay– Lower demand pressure at off peak times – the supplier will ‐

often cut the price to use up some of the spare capacity and increase total Revenue

Example -- Telephone call density highest during the daytimewhen businesses use the phones, lower at night

Third degree price discrimination

Consumers are identified in different market segments

A separate price is charged in each market segment

There are different price elasticities in each segment

This is the most common type of discriminationCinema management has identified 2 market

segments (adults and students)

3rd Degree : Market Separation

•Students have a more elastic demand because they have lower incomes.

• Monopolist seeks to maximize profits in each sub‐market

• Sell additional output in elastic market (lower price)• Reduce sales in inelastic market (increase price)• Prevent resale of the good or service• Examples of Market Separation / Segmentation– Discounts to Seniors / Senior Citizens– Prices for students and adults for rail and bus travel– Gender pricing in some bars/night clubs

loads of different examples of P.D such asPetrol stations: Gas stations will charge different prices in different neighbourhoods based on relative demand and location.Grocery stores: Offer coupons to price sensitive consumers (people whose demand is inelastic won’t bother to cut coupons, thus will pay more for the same products as price sensitive consumers who take the time to collect coupons).Quantity discounts: Grocery stores give discounts for bulk purchases by customers who are price sensitive (think “buy one gallon of milk, get a second gallon free”… the family of six is price sensitive and is likely to pay less per gallon than the dual income couple with no kids who would never buy two gallons of milk).•Providing college scholarships for low-income students but not wealthier ones

Hotel room rates: Some hotels will charge less for customers who bother to ask about special room rates than to those who don’t even bother to ask.Telephone plans: Some customers who ask their provider for special rates will find it incredibly easy to get better calling rates than if they don’t bother to ask.Damaged goods discounts: When a company creates and sells two products that are essentially identical except one has fewer features and costs significantly less to capture more price-sensitive consumers.Airline ticket prices: Weekend stayover discounts for leisure travelrs mean business people, whose demand for flights is highly inelastic, but who will rarely stay over a weekend, pay far more for a roundtrip ticket that departs and returns during the week. •Magazines such as Sports Illustrated offer gifts and discounts to new subscribers.

• Price discrimination can be a good and a bad thing Advantages to the firm: The firm can get a higher level of revenue from a given amount of sales.

The profits for the discriminating monopoly will be highest, the perfect competitor will be lowest, and the non-discriminating monopoly will lie in between

• Some consumers are brought into the market who might not havebeen able to afford the product

Both the firm and the consumer can benefit if prices are lowered accordingly

A firm can drive competitors out of the more elastic segment Profits gained from the inelastic market segment can be used to

lower prices in the elastic segment If a firm has a strong brand in its home country it can use those

profits to be aggressive in new elastic foreign markets (however, if can be proved to sell below production costs this is illegal according to the rules.)

Advantages to the consumer:

The consumer may be able to purchase a good or service that otherwise they could not afford

Lawyers often charge high prices to wealthy clients and lower prices to low income clients

Some people will be able to purchase the product at a lower price than they would have had to pay if the producer could not charge a higher price to others

Many universities charge foreign students higher tuition fees than for domestic students

Price discrimination usually increases total output so the product is available to more consumers

Disadvantages to the consumer :

The disadvantages to the consumer are:Consumer surplus is lostSome consumers will pay more than the price that would have been charged in a single, non-discriminated market

Is P.D good or bad?

• On the negative side, – it decreases consumer surplus while it increases a

firm’s profits• On the positive side,– It increases output– More consumers will now buy the product– It results in a more efficient output,

THANK YOU