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M63 Price Discrimination

Price Discrimination:

Practice of selling the same products to different buyers at different prices

• Airline Tickets (vacation vs. business)
• Movie Theaters (child vs. adult)
• HS football games (students vs. parents)
• Universities & Colleges……….

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Price discrimination seeks to charge each consumer what they are willing to pay in an effort to increase profits.

Those with inelastic demand are charged more than those with elastic (bus. trav. vs vacation traveler)

Requires the following conditions:

1. Must have monopoly power
2. Must be able to segregate the market into elastic and inelastic consumer demand
3. Consumers must NOT be able to resell product

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Price Discrimination

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Universities & Colleges

1. Must have control over price YES
2. Must be able to segregate the market YES
3. Consumers must NOT be able to resell product YES

Think of different groups/circumstances that incoming freshman at UW-Madison can be segregated into as we know that not everyone pays the same price!

Ex: In vs Out of state = 22k difference

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Demand =

MR

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Quantity

Price

For a price discrim. monopoly, the MR equals the demand

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Non Price Discriminating Monopoly vs.

Price Discriminating Monopoly

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D

MR

MC

ATC

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P

P_m

Q_m

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D

=MR

MC

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P

Q_nm

Identify the Price, Profit, CS, and DWL

Price Disc. Mon. can charge each person differently so the Marginal Revenue = Demand (Slide #9)

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D

=MR

MC

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P

Q_nm

Identify the Price (trick question), Profit, CS (trick questions), and DWL (trick question)

A perfectly discriminating can charge each person differently so the Marginal Revenue = Demand

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D

=MR

MC

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P

Q_nm

Identify the Price, Profit, CS, and DWL

A perfectly discriminating can charge each person differently so the Marginal Revenue = Demand

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ATC

Price Discrimination results in several prices, more profit, no CS, and a higher socially optimal quantity so no DWL

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Why no Consumer Surplus? Consumer Surplus is the space below what you would pay and what you did pay. Example: I would have paid $150 for a Packer playoff ticket, but only paid $100, which gave me the area between $150 and $100 as CS. With Perfect Price Discrimination, the price you pay is exactly what you are willing to pay, so there is no surplus that can be identified on the graph.

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In fact, Price Discrimination allows firms that are able to charge more than one price (if they can ID different price elasticity of demand) to “convert” consumer surplus to PROFIT.

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PRICE DISCRIMINATION ADDS TO PROFIT!!

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The greater the number of different prices charged, the more money it can extract from consumers

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HOW MUCH WILL A PERFECTLY PRICE-DISCRIMINATING MONOPOLIST PRODUCE? They will produce where PRICE=MC,

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Allocative Efficient point- Producing at the amount most desired by society, where MR (D)=MC. When this amount is made there is NO DWL.

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It is also the same amount made in Perfect Competition, with the price of the last item sold by a perfect price discriminator being the same price as would be found in PC. Only the last item. Of course, the consumer surplus in Perfect Competition is now Profit in Perfect Price Discrimination Monopolies!

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Government Policies on monopolies typically focus on preventing DWL, not preventing price discrimination.

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Price discrimination increases allocative efficiency (where D=S) because more of the units for which the willingness to pay exceeds the MC are produced and sold. NO DWL

Question 1

Which of the following enables a seller to capture the entire consumer surplus in a market?

(A) Perfect price discrimination

(B) Perfect competition

(C) An excise tax on buyers

(D) Effective price ceiling

(E) Effective price floor

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Question 2

In order for a firm to engage in price discrimination, it must be

(A) able to separate consumers into different groups based on demand elasticities

(B) producing in the inelastic portion of its demand curve to raise its price and increase total revenue

(C) a price taker

(D) experiencing economies of scale in the relevant range of production

(E) experiencing constant marginal cost

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Question 3

Which of the following is necessary for a firm to practice price discrimination?

(A) The government strictly enforces antitrust laws.

(B) The firm is a member of a cartel.

(C) The firm can prevent resale of its goods.

(D) The demand curve for the product is perfectly inelastic.

(E) The demand curve for the product is perfectly elastic.

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Question 4

Price discrimination occurs when

(A) the supply of the product is elastic

(B) a product’s average cost is greater than its average revenue

(C) a product’s average cost is less than its average revenue

(D) differences in a product’s price reflect differences in marginal costs

(E) differences in a product’s price do not reflect differences in costs of production

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Answers

1. (A) Being able to perfectly price discriminate means the firm captures all of the consumer surplus.

2. (A) How sensitive different consumers are determines how much they are willing to pay.

3. (C) Resale not possible. This is one of the conditions that make price discrimination possible.

4. (E) Prices with a discriminator are set by elasticity of the group, not production costs. This is a really tough question.

Mr. Clifford

Price Discrimination

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