Chapter 12
How large will the deadweight loss be if a profit maximizing firm engages in perfect first- degree price discrimination?
With perfect first-degree price discrimination there is no deadweight loss. The outcome is economically efficient because every consumer who purchases the good has a willingness to pay meeting or exceeding the marginal cost of production and every consumer who does not receive the good has a willingness to pay below marginal cost. Note, however, that while there is no deadweight loss, all of the surplus is captured by the firm leaving no consumer surplus.
1. Which of the following statements regarding price discrimination is true? a) In order to capture more surplus, the firm must have some market power. b) Third-degree price discrimination is illegal. c) Second-degree price discrimination refers to pricing differently for different market segments. d) First-degree price discrimination is relatively easy to implement.
a) In order to capture more surplus, the firm must have some market power.
1. What is the difference between uniform pricing and price discrimination? a) Uniform pricing and price discrimination are the same. b) With uniform pricing firms charge different prices for the same good or service and with price discrimination firms charge the same price for the same good or service. c) With uniform pricing firms charge the same price for the same good or service and with price discrimination the firms charge different prices for the same good or service. d) The uniform price is always higher than the discriminated price.
c) With uniform pricing firms charge the same price for the same good or service and with price discrimination the firms charge different prices for the same good or service
1. When a firm engages in __________, every unit of output is sold at the same price; when a firm engages in ___________, different consumers are charged different prices for the same good. a) arbitrage; uniform pricing b) price discrimination; uniform pricing c) uniform pricing; price discrimination d) surplus capturing; price discrimination
c) uniform pricing; price discrimination
A monopolist price discriminates if
charges more than one price for the same good or service.
A monopolist charges a uniform price
if it sets the same price for every unit of output sold.
Calculating the optimal block tariff will involve three steps:
1. Expressing Q2 in terms of Q1. 2. Expressing producer surplus (PS) in terms of Q1. 3. Finding the value of Q1 that maximizes PS, using that value to calculate P1 and Q2, and using the value of Q2 to calculate P2. Step 1. The segment BE is what's left of the consumer's demand curve after purchasing the first block Q1. The marginal revenue curve associated.... continues in pic
Screening
A process for sorting consumers based on a consumer characteristic that (1) the firm can see (such as age or status) and (2) is strongly related to a consumer characteristic that the firm cannot see but would like to observe (such as willingness to pay or elasticity of demand).
versioning
A strategy of selling two or more versions of a product with different quality levels at different prices.
How might screening help a firm price discriminate? Give an example of screening and explain how it works.
Screening is a mechanism that allows a firm to sort consumers according to their willingness to pay or their price elasticity of demand. For example, the firm might screen the consumers based on some observable consumer characteristic such as age. This allows the firm to charge a price closer to the consumer's willingness to pay given that the characteristic, such as age, is correlated with willingness to pay. In addition, because the characteristic is observable, it is possible for the firm to prevent arbitrage.
"Willingness to Pay" Curve
The consumer's maximumwillingness to pay is called the consumer's reservation price.
Suppose a company is currently charging a uniform price for its two products, creamy and crunchy peanut butter. Will third-degree price discrimination necessarily improve its profit? Would the firm ever be worse off with price discrimination?
The firm could never do worse with third-degree price discrimination than without it because the firm could always charge the uniform price and earn the same profit. So long as the firm can reliably identify a difference in willingness to pay among its customers and prevent resale, third- degree price discrimination should in fact increase its profits.
Certain market features must be present for a firm to capture more surplus with price discrimination:
• A firm must have some market power to price discriminate. . The firm must have some information about the different amount people will pay for its product. . a firm must be able to prevent a resale, or arbitrage. If the firm cannot prevent resale, then a customer who buys at a low price can act as a middleman, buying at a low price and reselling the good to other customers who are willing to pay more for it. In that case, the middleman, not the firm that sells the good initially, captures the surplus.
Why must a firm have at least some market power to price discriminate?
If a firm has no market power it will not be able to price discriminate to increase profits. Without market power the firm is a price taker and has no ability to set different prices for different units of output. As the firm attempts to set higher prices for some units, consumers will simply purchase elsewhere if the firm has no market power.
Suppose a profit-maximizing monopolist producing Q units of output faces the demand curve P = 20 - Q. Its total cost when producing Q units of output is TC = 24 + Q2. The fixed cost is sunk, and the marginal cost curve is MC = 2Q. a) If price discrimination is impossible, how large will the profit be? How large will the producer surplus be? b) Suppose the firm can engage in perfect first-degree price discrimination. How large will the profit be? How large is the producer surplus? c) How much extra surplus does the producer capture when it can engage in first-degree price discrimination instead of charging a uniform price?
If price discrimination is impossible the firm will set MR = MC . 20 - 2Q = 2Q Q=5 At this quantity, price will be P =15, total revenue will be TR = 75, total cost will be TC = 49 , and profit will be r = 26 . Producer surplus is total revenue less non-sunk cost, or, in this case, total revenue less variable cost. Thus producer surplus is 75 - 5^2 = 50 . b... pic attached
Why must a firm prevent resale if it is to price discriminate successfully?
If the firm cannot prevent resale, then customers who buy at a low price can act as middlemen and resell the goods to customers willing to pay more. In this case the firm won't earn the additional surplus; the middlemen will capture the surplus instead of the firm.
Example MC = 2P = 20 - Q What is producer surplus if uniform pricing is followed?
MR = P + (∆P/∆Q)Q = 20 - Q - Q = 20 - 2Q MR = MC => 20 - 2Q = 2 => Q* = 9 P* = 11 PS= Revenue-TVC = PQ-2Q = 11(9)-2(9) = 81
Forms of Price Discrimination
A policy of first degree (or perfect) price discrimination prices each unit sold at the consumer's maximum willingness to pay. This willingness to pay is directly observable by the monopolist. A policy of second degree price discrimination allows the monopolist to offer consumers a quantity discount. A policy of third degree price discrimination offers a different price for each segment of the market (or each consumer group) when membership in a segment can be observed.
Does a firm need to be a monopolist to price discriminate?
No, a firm does not need to be a monopolist to price discriminate. The firm simply needs to have market power and face a downward sloping demand curve.
IMPLEMENTING THE SCHEME OF PRICE DISCRIMINATION: BUILDING "FENCES"
Building a "Fence" to Implement a Scheme of Price DiscriminationPanel A shows the case of a firm that offers a product of the same quality at different prices. Panel B shows how the firm can build a "fence" by offering a high-quality version of the product at a high price (point A) and a low-quality version of the good at a low price (point C). Group alpha consumers (low-price sensitivity and high-quality sensitivity) prefer version A to version C, while group beta consumers (high-price sensitivity and low quality sensitivity) prefer version C to version A).
Block Pricing
if the monopolist could set a different block price for each customer, it would capture the same amount of surplus as a perfectly price discriminating monopolist.
What is the difference between a uniform price and a nonuniform (nonlinear) price? Give an example of a nonlinear price.
With a uniform price the firm sells every unit to every consumer at the same price. With non- uniform or nonlinear pricing, the firm charges different prices for different units of output. For example, a telephone company might charge each user a subscription fee of $10 and then a usage fee of $0.05 per call. Nonlinear pricing is one type of second-degree price discrimination. With second-degree price discrimination, the firm charges a lower average price to consumers who are willing to buy large quantities of the good.
What are the differences among first-degree, second degree, and third-degree price discrimination?
With first-degree price discrimination, the firm charges each consumer a price close to the consumer's maximum willingness to pay. In this way, the firm is able to extract virtually all the available surplus for itself. With second-degree price discrimination, the firm offers quantity discounts. This induces some customers to purchase more than they would if all units were priced the same. With third-degree price discrimination the firm charges different prices to different market segments. For example, the firm might charge a lower price to students and senior citizens to induce them to purchase when they might not otherwise.
With first-degree price discrimination, why is the marginal revenue curve the same as the demand curve?
With perfect first-degree price discrimination the marginal revenue and demand curves are the same. This is because with perfect first-degree price discrimination the firm charges each consumer their maximum willingness to pay, as measured by the demand curve. Therefore, the demand curve represents the additional revenue the firm will bring in for each additional unit it sells, or marginal revenue. Note, with perfect first-degree price discrimination the firm charges each individual a different price, so as it lowers its price to gain marginal customers it doesn't lose revenue on the infra-marginal customers who would have paid a higher price.
Which of the following are examples of first-degree, second-degree, or third-degree price discrimination?a) The publishers of the Journal of Price Discrimination charge a subscription price of $75 per year to individuals and $300 per year to libraries. b) The U.S. government auctions off leases on tracts of land in the Gulf of Mexico. Oil companies bid for the right to explore each tract of land and to extract oil.c) Ye Olde Country Club charges golfers $12 to play the first 9 holes of golf on a given day, $9 to play an additional 9 holes, and $6 to play 9 more holes.d) The telephone company charges you $0.10 per minute to make a long-distance call from Monday through Saturday and $0.05 per minute on Sunday.e) You can buy one computer disk for $10, a pack of 3 for $27, or a pack of 10 for $75.f) When you fly from New York to Chicago, the airline charges you $250 if you buy your ticket 14 days in advance, but $350 if you buy the ticket on the day of travel.
a) Third degree - the firm is charging a different price to different market segments, individuals and libraries. b) First degree - each consumer is paying near their maximum willingness to pay. c) Second degree - the firm is offering quantity discounts. As the number of holes played goes up, the average expenditure per hole falls. d) Third degree - the firm is charging different prices for different segments. Business customers (M-F) are being charged a higher price than those using the phone on Sunday, e.g., family calls. e) Second degree - the firm is offering a quantity discount. f) Third degree - the airline is charging different prices to different segments. Those who can purchase in advance pay one price while those who must purchase with short notice pay a different price.