IO Ch. 10

Probably one of the common phenomenon in microeconomics is price discrimination, and yet most economic models assume that firms selling similar goods charge similar prices. The reality is that there are considerable differences in prices for similar goods, suggesting that firms discriminate based on price. We have all experienced price discrimination - student discounts at theaters, airline prices, etc. Why does price discrimination exist and how is it done?

1. differing demand elasticities or willingness to pay

2. the ability to distinguish between different types of consumers

3. difficulty in reselling product

4. imperfect information

All of these do not have to be in place, ut at least some do, in order for price discrimination to take place. For instance, even though reselling may be difficult and in some cases illegal, it often occurs.

Ex: Levis.

What does the law say about price discrimination?

In some cases it is illegal, but in some cases the law encourages and protects price discrimination by making reselling illegal.

Or in some cases (such as added security measures at airports) laws may inadvertently make price discrimination easier.

Models of price discrimination.

1. First degree or perfect price discrimination

2. Second degree price discrimination

Definition 1: Does not require #2 to hold, but does require #1 to hold.

Definition 2: Nonlinear pricing (prices do not depend on consumers, but on quantity - some would argue though that these two factors cannot be separated.)

3. Third degree price discrimination

Requires that #2 hold.

a. Spatial price discrimination.

Ex: Jerusalem

b. Versioning

Ex: Airlines' seating classes

"Student" computer programs

The book includes some incredible examples of firms which have 'damaged' or disabled products deliberately, to create two different products (in an attempt to force those who want the complete package to pay more and to also capture those who are unwilling to pay that difference. Pretty nasty stuff... (The book argues that everybody is made better off, but if the company can manufacture a computer with a math chip and then disable that math chip and sell it cheaper, why doesn't it just sell the computer cheaper and skip disabling the math chip! I find the book's conclusion somewhat problematic. Basically the company is simply trying to extract more consumer surplus, without any justification based on cost.)

c. Bundling

i. pure bundling (all or nothing)

ii. mixed bundling

d. Durable good pricing (timing of sales)

women's fashion is an extreme example of this.

Can you think of examples of each?

Models of each:

1. Graph of perfect price discrimination.

All of consumer and producer surplus extracted by producer. No dead weight loss, but transfer of welfare.

2. Model with two different demand curves:

Those with more elastic demand will pay lower price.

What might contribute to lower demand elasticity?

Some dead weight loss but less than in the case of simple monopolist.

So there is a trade off - price discrimination reduces dead weight loss and increases the number of consumers who can purchase a good, but deprives consumers of their surplus.

US government has objected to price discrimination because it may reduce competition. (Ie firms may use it to try to push out competitors.

Tension between the benefits of lower prices and the possibility of increased concentration.

Also tension between ability to pay. Why shouldn't those who earn less and can afford less (and as such have higher elasticity) be offered lower prices?

In other words, there are advantages and disadvantages to price discrimination.

In addition, it is not always clear if two products are identical and thus if price discrimination is taking place.