Intermediate Microeconomic Theory: Chapter 10
How much should each segment be charged equation?
(P - MC) / P = - 1 / Ed
What is area L in indirect price discrimination?
Area L is the downside of switching from group one to group 2 (i.e. uninterested traders (inelastic) switching to interested traders group (elastic))
What is a way companies try to limit resale and arbitrage?
By instituting limits or quotas of the number of goods one may buy
In versioning, who gets the cheaper option and who gets the more expensive option?
Inelastic = more expensive Elastic = cheaper
With versioning do the different versions of marginal cost need to be the same?
No, all that is necessary for versioning to work is the markup of price over marginal cost to be higher for versions bought by customers with more inelastic demand
Pricing Strategy Graph Can the firm directly identify customers individual demands before they buy the product?
No: indirect (second-degree) price discrimination such as quantity discounts, versioning, and coupons. Also bundling and block pricing & two part tariffs
Pricing Strategy Graph Can the firm prevent resale and arbitrage?
No: monopoly produces quantity at which MR = MC and selects price that way Yes: do the customers have different demand curves?
Pricing Strategy Graph Does the firm have market power?
No: perfect competition and produces quantity at which MR = P = MC Yes: can the firm prevent resale and arbitrage
What is the equation for PS and profit?
PS: (P - MC) × Q Profit: ((P - MC) × Q) - FC Profit: TR - TC
Pricing Strategy Graph Direct price discrimination when the firm has information on groups of costumers
Use segmenting (third-degree) price discrimination
How do you price bundles?
When bundling you price each part of the bundle at the lowest of the customers evaluation to guarantee everyone can purchase
When is preventing resale not a problem?
When firms can identify who has a higher or lower willingness to pay before purchase
What is consumer surplus and DWL under perfect price discrimination?
0
Ways to directly segment customers?
1. By customer characteristics 2. By past purchase behavior 3. By location 4. Over time
Mathematical and Graph Steps Indirect Price Discrimination
1. Find group 1 and group 2's quantity and price combination through MR = MC 2. Mark the elastic groups (group 2) price and quantity through point X (found using group 2's own MR = MC process) 3. Mark the inelastic groups (group 1) price and quantity. 4. Put group 2's price in group 1's demand function to find Qmax 3. Consumer surplus is Area A + B - L 4. If inelastic groups new surplus A + B - L > old surplus A, it is not incentive compatible for them 5. We use the inelastic group / group 1's graph to make this comparison
Two-Part Tariffs Steps
1. Produce at a price and quantity where P = MC 2. Set the consumer surplus as a fixed fee to eliminate all consumer surplus and turn it into producer surplus DWL = 0 CS = 0 PS = Everything
Indirect Price Discrimination (Second-Degree Price Discrimination) When to Use It
1. The firm has market power and can prevent resale and arbitrage 2. The firm's customers have different demand curves 3. The firm cannot directly identify which customers have which type of demand before they purchase
Advanced Pricing Strategies When to Use It Block Pricing Two-Part Tariffs
1. The firm has market power and can prevent resale and arbitrage 2. The firm's customers may have either identical or different demand curves
Perfect/First-Degree Price Discrimination When to Use It
1. The firm has market power and can prevent resale and arbitrage 2. The firm's customers have different demand curve (differ in their willingness to pay) 3. The firm has complete information about every customer and can identify each ones demand before they pay. Knows each individual's demand curve
When can a firm pursue a pricing strategy?
1. The firm must have market power. Without market power (PC) firms are price takers and cannot choose their prices at all much less price discriminate 2. The firm must prevent resale and arbitrage If resale and arbitrage can happen it prevents the firm from charging higher prices because they customers will just by the good from other customers causing them to lose business
Bundling When to Use It
1. a firm has market power and can prevent resale and arbitrage 2. A firm sells a second product and consumers demand for that product is negatively correlated with their demand for the first product
Segmenting/Third-Degree Price Discrimination When to Use it
1. the firm has market power and can prevent resale and arbitrage 2. the firm's customers have different demand curves 3. the firm can directly identify specific groups of customers (not individuals) with different price sensitivities before purchase
How do you combine two segmented groups
1. turn them both into Q = 2. Add them up 3. Set MR = MC 4. Produce a kink at the lowest willingness to pay (the lowest intercept) 5. put that price into the new demand function to find which Q is with that price
What is effect of perfect price discrimination without market power?
A loss in producer surplus and a demand curve that is below price and the orginal demand curve
What is the surplus distribution in perfect price discrimination (first-degree)?
All of the surplus goes to the producers. There is no consumer surplus and no deadweight loss
Why do segmented groups charge different prices to customers even though MC is the same?
Because you are charging differently because the groups have different demand elasticities
Does arbitrage make consumers better or worse off?
Better off because the low-paying customer can make a profit and the high-paying customer can buy the product for a lower price than the firm would've charged
When is bundling not a price discrimination strategy?
Bundling that occurs because the goods are strong complements to each other (they never sell one shoe singularly, they sell both together) is not a price discrimination strategy
How does versioning work?
Camry is priced at $26,000, and the Lexus is priced at $38,000 Camry worth: $28,000 Lexus work: $31,000 Budget Consumers would make a surplus of $2,000 from buying the Camry and -$7,000 from buying the Lexus making it incentive compatible for them to buy the Camry Camry worth: $31,000 Lexus work: $43,000 Luxury Consumers would make a surplus $4,000 from buying the Camry and $5,000 from buying the Lexus making it incentive compatible for them to buy the Lexus
What are some examples of perfect price discrimination?
Car negotiations and financial aid packets
Pricing Strategy
Definition: a firms methods of pricing its product based on market characteristics
Indirect Price Discrimination (Second-Degree Price Discrimination)
Definition: a pricing strategy in which customers pick among a variety of pricing options offered by the firm
Direct Price Discrimination
Definition: a pricing strategy in which firms charge different prices to different customers based on observable characteristics of customers. can increase producer surplus.
Perfect Price Discrimination (First-Degree Price Discrimination)
Definition: a type of direct price discrimination in which a firm charges each customer exactly his willingness to pay / charges each buyer a different curve
Direct Price Discrimination II: Segmenting/Third-Degree Price Discrimination
Definition: a type of price discrimination in which a firm charges different prices to different groups of people based on identifiable attributes of those groups. Firms must be able to directly identify groups of customers with different demands than other buyers (ex. through school IDs)
Quantity Discounts
Definition: the practice of charging a lower per-unit price to customers who buy larger quantities Indirect Price Discrimination through Quantity Discounts
Price Discrimination
Definition: the practice of charging different prices to different customers for the SAME product, done by firms with market power
Arbitrage
Definition: the practice of selling a product at a price higher than its original selling price
Incentive Compatibility
Definition: the requirement under an indirect price-discrimination strategy that the price offered to each consumer group is chosen by that group
What do any trades between Qmax and Qo do?
Destroy consumer surplus for the inelastic group
How do you find the difference between price discriminations and price differences without observing the MC?
Find something that changes the price elasticity without changing the costs. If the prices changes with elasticity without changing the costs, that price discrimination
Advanced two part tariffs occur when consumers have different demand curves
For high demand customers since there is a larger consumer surplus, the fixed fee will higher and low demand customers won't buy anything For low demand customers the fixed fee (aka the consumer surplus) will be smaller so if you set the fixed fee based on low demand customers you leave a lot of surplus to the relatively high demand consumers
Can bundling allow a firm with market power in one industry to leverage its market power into a second industry
Generally, no
What type of demand will lead to large producer surplus when segmenting?
Groups with higher willingness to pay, less price sensitive, more inelastic, and steeper demand curves
What type of demand will lead to smaller producer surplus when segmenting?
Groups with lower willingness to pay, more price sensitive, more elastic, and flatter demand curves
What does versioning require?
Incentive compatibility and customers with different elasticities
If the marginal costs of producing two similar (but not the same) are different and that is what causes differences in price, is that price discrimination?
No, it is simply just a price difference
Pricing Strategy Graph Do the customers have different demand curves?
No: advanced pricing strategies such as block pricing and two part tariffs Yes: Can the firm directly identify customers individual demands before they buy the product?
Indirect Price Discrimination through Coupons
Those who go through the trouble of looking for coupons are more likely to have elastic demand Firms require customers to go through the effort of finding and using coupons because that is how they differentiate those with inelastic vs elastic demand naturally Those who have inelastic demand will likely not go through the effort of finding and using a coupon so they won't get the benefit
In a industry with price discrimination who pays higher prices?
Those willing to pay for it
With block pricing, how is the first block set?
Through using the single price monopolist method of MR = MC
When is producer higher from segmented groups or single-price monopolists
segmented groups
Bundling
a pricing strategy in which the firm sells two or more products together at a single price an indirect price discrimination strategy
Two-Part Tariffs
a pricing strategy in which the payment has two components, a per unit price and a fixed fee
Mixed Bundling
a type of bundling in which the firm simultaneously offers consumers the choice of buying two or more products separately or as a bundle
Pure Bundling
a type of bundling in which the firm offers the products only as a bundle
How do you determine the price each segment should be charged?
P1 = {E1 / (1 + E1)} × MC Divided by P2 = {E2 / (1 + E2)} × MC * the greater the differences in elasticity, the greater the ratio in prices
Price Discrimination vs Price Differences
Price discrimination implies that a firm with market power sets it price based on the elasticity of demand and the marginal cost of producing. Price differences demand only on marginal costs
What are the differences between price discrimination and price variations
Price variations are due to differences in marginal cost. Price discrimination is due to the greediness of firms and because firms with market power have the ability to charge different prices for the same product
Segmenting Quantity found in Group 1 + Quantity found in Group 2 =
Quantity found using Market Demand Equation
What happens when monopolist firms charge different prices to different groups of customers?
Raise surplus and profit higher than monopolists who charge the same price
What is the pricing strategy for regular monopolies?
Set the market price according to the quantity of output chosen
If you were combining two segmented groups into one what would you do?
Take each equation, turn them into Q =, add them up to find the market demand equation, and use the same method of MR = MC.
What is the complication with segmenting things based on time>
The complication with pricing over time is that it is only segmented if the seller directly assigns customers to a given time period However is customers are forward-looking and take into account that sellers might segment them over time then the sellers can not actually directly segment its customers since they cannot prevent customers from changing groups as the buyer decides when to buy The more forward looking customers are the more segmenting across time actually becomes indirect price discrimination
Is the consumer better or worse off in Two-Part Tariffs
The consumer is no worse off than if she bought nothing
What does direct price discrimination hinge on?
The firm's ability to distinguish consumers demand for the product before purchase
Block Pricing Steps
The first 100 are sold at 25 cents, numbers 101 to 125 are sold at 20 cents etc. Numbers 101 to 125 generate extra consumer surplus area B and producer surplus area C When you word it you can say buy 100 for $25, 125 for $30, 175 for $35
For indirect price discrimination, whose graph do we use?
The more inelastic groups, steeper curve
What quantity will be sold in a perfect price discrimination (first-degree)?
The same quantity sold in perfectly competitive market. The quantity where P = MC.
How does a segmented graph look different when you've combined the segmented groups into one equation.
There is a kink on the price of the group with the lower willingness to pay. The quantity for this kink is the price inputted into the inverse demand equation. You also have to do MR = MC to find the price and quantity of the market demand equation.
Do single price and segmenting monopolistis differ in the prices and quantity they set?
They differ in the prices but not always the quantity. However even if its the same quantity you're selling to a different group of people because since price changes the audience who is willing and able to buy is different
Versioning Indirect Price Discrimination
a pricing strategy in which the firm offers different product options designed to attract different types of consumers ex. airlines offer business, first class, etc and people seperate themselves based on their demand curve
When do quality discounts work best
To work, customers who buy larger quantities of a product need to have relatively more elastic demands than consumers who buy smaller quantities (more purchases, lower prices) If they are more elastic, when you offer them a drastically lower price for more quantities purchased they will be more likely to take it Those who buy the most (obsessed), need to be the most elastic, and you give them a discount
Pricing Strategy Graph Direct price discrimination when the firm has complete information about every customer
Use perfect (first-degree) price discrimination
Does arbitrage make firms better or worse off?
Worse off because they are only able to sell the goods to low-paying customers instead of taking advantage of other customers willingness to pay putting them back in a single price monopoly
How do you find producer surplus for segmented groups?
You add up both groups separate producer surplus for the combined producer surplus
How do you solve for quantity and price when segmenting?
You treat each group as a seperate market so separate graphs and demand curves. You solve using MR = MC and use each groups demand equation to figure out the price each group will be charged. MC will be the same for both groups but MR and the inverse demand curve will differ
Does customer sorting need to occur in block pricing
no
Market demand of segmented groups is also _____ because you are combining the two equations to solve for one price instead of two
single-price
Block Pricing
the practice of reducing the price of a good when the customers buys more of it does not require that buyers have different demand curves and price sensitivities
When do firms receive producer surplus when bundling?
when the willingness to pay for that two goods is now negatively correlated across the consumers
