price discrimination

price discrimination

selling the same product at different prices to different customers, when the cost of serving them is the same

• price differences are not explained by cost differences

• charge higher prices to customers with higher willingness to pay, and lower prices to more price-sensitive customers

reservation price

the maximum price a customer will pay for a product

• equal to their marginal benefit

perfect price discrimination

charging each customer exactly their reservation price

• extreme benchmark → firms usually can’t observe exact willingness to pay

no price discrimination graph

perfect price discrimination graph

MR curve = demand bc we are charging everyone exactly what they’re willing to pay

imperfect price discrimination graph

selling based on willingness to pay for certain groups that you know

efficiency graph - no PD

CS → under D above P

PS → above MC (S) below P

DWL → below D above ATC

efficiency graph - perfect PD

CS → no CS bc D = P you are charging ppl exactly what their demand is

PS → above MC (S) below P

efficiency graph - imperfect PD

CS → under D above P

PS → above MC (S) below P

DWL → below D above ATC

steps to price discrimination

1. charge higher prices to those who will pay them

   • higher margins, more producer surplus, surplus shifts from buyers to sellers

2. offer selective discounts to induce new customers to buy

   • raises quantity, still above MC, increases total surplus

when can firms do PD?

1. have market power (downward sloping demand)!

   • no MP = no ability to set own prices

2. have the ability to prevent resale

3. have the ability to target different prices to different customers

group pricing

charge different prices to different groups, segment the market when you cannot observe individual reservation prices

• different demand curves → different prices

  • higher prices for groups with higher marginal benefit

  • lower prices for groups that are more price-sensitive

• type of price discrimination (PD), but NOT perfect PD

• ex. movie ticket pricing

  • students and seniors are more price sensitive, so they pay lower prices

• base discounts on verifiable and difficult-to-change characteristics

  • ex. asking for student ID for student discounts, age

  • but can fail → passing around student IDs

• ensure customers cannot easily switch into discount groups

hurdle method

• lower prices for offered only to buyers willing to overcome an obstacle

• high WTP customers pay full price, low WTP customers sort into the discount by jumping the hurdle

• examples:

  • alternative versions and timing

  • fluctuating prices

  • haggling

  • bundling

  • misc: quantity discounts (B2G1), rebate forms, cosmetic damage pricing

hurdle - alternative versions and timing

• big fans pay more to see movies opening weekend

• low WTP customers wait for discounts later

hurdle - fluctuating prices

• different items on sale at different times

• example: grocery store flyers

• hurdle: switch brands or time purchases

hurdle - haggling

• price tailored individually but cost is time/effort

• high WTP avoid the hassle, low WTP will haggle

huurdle - bundling method

• bundle desirable and less-desirable goods

• screens by willingness to accept extra goods to save money