PRICE DISCRIMINATION BY INDICATORS Overview Context: Frequently, - - PowerPoint PPT Presentation

PRICE DISCRIMINATION BY INDICATORS

Overview

• Context: Frequently, firms charge different prices to different

market segments

• Concepts: market segmentation, elasticity rule
• Economic principle: If you charge different prices for the same

product, expect arbitrage

Motivation

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

D

MC MR

pM qM p q A π B

Profit lost to buyers who are willing to pay more than pM Profit lost due to consumers who do not buy even though there are gains from trade

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Example: laptop pricing

• Production cost is $1,200
• Three types of buyers:

Type W.T.P. ($)

• No. (K)
• Cum. No.

1 3000 10 10 2 2000 20 30 3 1000 30 60

Example (cont.)

• Strategy 1: Price at $3000

Profit = ($3000−$1200) × 10K = $18m

• Strategy 2: Price at $2000

Profit = ($2000−$1200) × 30K = $24m

• Strategy 3: Price at $3000 for Type 1

Price at $2000 for Type 2 Profit = ($3000−$1200) × 10K + + ($2000−$1200) × 20K = $34m

• Bottom line: If price discrimination is possible, it pays

Customer markets

• In many markets, the number of customers is relatively

small and the seller has considerable information about buyers

• Examples: ready-mixed concrete, large commercial

aircraft, enterprise software, tug boat push services

• Although there is a list price (rack rate), each customer

receives a discount (often negotiated)

• Final price depends on customer’s ability to pay,

bargaining power

Perfect price discrimination

• Each customer is charged a different price — exactly his/her

willingness to pay (“from each, according to his/her willingness”)

• Examples: plumber, lawyer, piano teacher; customer markets
• With respect to normal pricing,

− The seller gains: revenue and profits go up − The low-price buyer often gains − The high-price buyer often loses

• Net effect: not clear whether this is good or bad for society as a
• whole. It depends!

Practical difficulties

• Market research: group identification
• Arbitrage: resale, gray markets, harvesting
• Legal limits, US: injury to competition
• Legal limits, EU: single market
• Coming next: All approaches to PD are approximations

to PPD; we will talk about some possible strategies

Types of price discrimination

• Perfect price discrimination
• By indicators: market segment can be directly identified

− Trick: apply elasticity rule to each market segment

• By self-selection: market segment cannot be directly identified

− Trick: offer options such that each consumer will pay what they are willing to pay

Discrimination by indicators

• Different segments can be identified directly

(i.e., it’s easy to know who’s who)

• Examples?
• Rule: different elasticities ⇒ different prices.

Specifically, higher prices in less elastic markets (elasticity rule): pi − MC pi = 1 −ǫi where ǫi ≡ d qi d pi pi qi

Markups on European cars

Model Belgium France Germany Italy UK Fiat Uno 7.6 8.7 9.8 21.7 8.7 Nissan Micra 8.1 23.1 8.9 36.1 12.5 Ford Escort 8.5 9.5 8.9 8.9 11.5 Peugeot 405 9.9 13.4 10.2 9.9 11.6 Mercedes 190 14.3 14.4 17.2 15.6 12.3

• What’s going on here?

Takeaways

• Key issues for price discrimination are:

− Identifying market segments − Avoiding arbitrage

• With clear, separate segments: apply elasticity rule to each

separately