Week 7 - Price Discrimination (First and Third Degree)

What is price discrimination?

A firm engages in price discrimination when it charges different prices for the same good based on individual characteristics, identifiable subgroups, or quantity purchased.

What are the necessary conditions for price discrimination?

1. The firm must have market power. 2. The firm must identify consumers willing to pay more. 3. The firm must prevent or limit resale between customers charged different prices.

What is first-degree price discrimination?

First-degree price discrimination occurs when the monopolist charges the maximum each consumer is willing to pay for each unit of the product.

What is second-degree price discrimination?

Second-degree price discrimination involves nonlinear pricing where consumers self-select based on their preferences, such as quantity discounts.

What is third-degree price discrimination?

Third-degree price discrimination involves charging different prices to different groups based on observable characteristics, while each customer in a group pays the same price.

Why do firms engage in price discrimination?

Firms can earn higher profits by charging higher prices to customers willing to pay more and selling to customers who would not pay the uniform price.

What is the monopolist's problem in pricing?

The monopolist must balance the revenue from selling additional units against the revenue lost from lowering the price on all units sold.

What happens under uniform pricing?

Under uniform pricing, some units with quantities above the monopolist's optimal quantity are not sold, even though consumers' willingness to pay is above marginal cost.

What is the outcome of first-degree price discrimination?

First-degree price discrimination leads to the monopolist producing where price equals marginal cost, maximizing total welfare but leaving consumers with zero surplus.

What is the implication of third-degree price discrimination?

The monopolist charges higher prices in the group with less elastic demand, maximizing profits by segmenting consumers.

How does a monopolist determine prices in different markets?

The monopolist sets different prices based on the aggregate demand curves of each market, maximizing profit in each segment.

What is the formula for the monopolist's profit under price discrimination?

Π = P1(Q1)Q1 + P2(Q2)Q2 − C(Q), where Q = Q1 + Q2.

What is the first-order condition for profit maximization in group pricing?

For group 1: P1(Q1) + P'1(Q1)Q1 = C'(Q). For group 2: P2(Q2) + P'2(Q2)Q2 = C'(Q).

What is an example of first-degree price discrimination?

An example is a car dealer negotiating the price of a car based on the buyer's willingness to pay.

What is an example of second-degree price discrimination?

An example is a utility company offering lower rates for higher usage tiers.

What is an example of third-degree price discrimination?

An example is a movie theater offering discounted tickets for students and seniors.

What is the relationship between price elasticity of demand and pricing?

The monopolist charges a higher price in the group with less elastic demand, as they are less sensitive to price changes.

What does the term 'reservation price' refer to?

The maximum amount a consumer is willing to pay for a good.

What is the significance of preventing resale in price discrimination?

Preventing resale allows the monopolist to maintain different prices across segments without consumers arbitraging the price differences.

What is the competitive outcome in first-degree price discrimination?

Under first-degree price discrimination, the price and quantity sold coincide with the competitive outcome, maximizing total welfare.

What is deadweight loss in the context of price discrimination?

Deadweight loss refers to the loss of economic efficiency when the equilibrium outcome is not achievable or not achieved.

What is the effect of price discrimination on consumer surplus?

Price discrimination typically results in zero consumer surplus, as the monopolist captures all surplus.

How does a monopolist's marginal cost affect pricing decisions?

The monopolist sets prices based on the marginal cost of production, aiming to maximize profit while considering demand elasticity.

What is the impact of market power on price discrimination?

Market power allows a firm to set prices above competitive levels, enabling price discrimination strategies.

What is the role of consumer identification in price discrimination?

Identifying consumers allows firms to segment the market and tailor pricing strategies to maximize profits.

What is the outcome of a single pricing strategy compared to price discrimination?

A single pricing strategy may result in lower profits compared to price discrimination, as it does not capture the full consumer surplus.

What is a two-part tariff?

A pricing strategy where consumers pay a lump-sum fee to access a product and then a linear price for each unit purchased.

How does a two-part tariff affect average cost per unit?

The average cost per unit increases if fewer units are purchased due to the access fee.

What is the marginal cost of production in the example provided?

The marginal cost of production is constant at c = 10.

What is the demand curve for consumers in the example?

The demand curve is given by q = 80 - p.

What quantity is sold when price equals marginal cost?

When p = c = 10, the quantity sold is q = 70.

What happens to consumer surplus when the monopolist charges a lump-sum access fee?

Consumer surplus becomes zero as the monopolist captures it as producer surplus.

What is the total profit for the monopolist when charging the access fee of 2450?

The total profit per consumer is 2450.

What is the total profit when the price is set higher than marginal cost (p = 20)?

The total profit is 2400, which is less than the profit from charging p = MC.

What are the demand curves for Valerie and Neal?

Valerie's demand: q1 = 80 - p; Neal's demand: q2 = 100 - p.

What is the total profit when the monopolist charges different access fees for Valerie and Neal?

The total profit is 6500.

What is the deadweight loss when the monopolist charges the same access fee to both consumers?

The deadweight loss is the area C1 + C2 = 100.

What happens to Valerie's consumer surplus when the access fee equals her entire surplus?

Valerie has no consumer surplus left.

What is the profit-maximizing price when the monopolist serves both types of consumers?

The profit-maximizing price is p = 20.

What is the access fee when the monopolist serves both types of consumers?

The access fee equals Valerie's surplus at this price, A = 1800.

What is the utility function for a consumer consuming q units?

U = θ/2 * (q - q^2) - T.

What proportion of consumers are low-type in the simple model?

A proportion λ = 3/4 of consumers are low type.

What is the demand for low-type consumers?

Low-type consumers' demand is q1 = 1 - p.

What is the aggregate demand at price p when serving both types?

D(p) = 3/4(1 - p) + 1/4(2(1 - p)) = 1 - 7/8p.

What is the first-order condition for profit maximization?

The first-order condition is dπm/dp = 0.

What is the optimal access fee when the marginal cost is c = 2/7?

The optimal access fee is A = 2/9.

What happens to the monopolist's profit when excluding low-demand consumers?

Excluding low-demand consumers leads to a deadweight loss equal to Valerie's entire surplus.

What is the profit when the monopolist charges Neal's surplus as the access fee?

The profit is 4050, which is less than the profit when charging Valerie's surplus.

What is the relationship between access fees and consumer surplus?

Access fees can be set to capture consumer surplus, potentially leading to zero consumer surplus.

What is the effect of setting a price higher than marginal cost on total profit?

Setting a price higher than marginal cost can decrease total profit compared to charging marginal cost with a higher access fee.

What is the significance of knowing each consumer's demand curve for the monopolist?

It allows the monopolist to set different prices and access fees for different consumers.