Module 10.4 Price Discrimination Pt. 1 Lecture

Market Power and Pricing

• Market Power Definition: The ability of a firm to set prices above marginal cost due to a lack of perfect competition.
• Demand Curve: A firm with market power faces a downward-sloping demand curve, meaning as price increases, the quantity sold decreases.
  • Key Characteristics:
  • When the firm raises prices, it sells fewer units.
  • Must balance:
    • Output Effect: Selling more units at a lower price.
    • Discount Effect: Reducing prices for all units sold.

Price Discrimination

• Definition: Selling the same good at different prices to different customers, based on their willingness to pay.
• Conceptual Framework:
  • Price discrimination does not relate to bigotry or prejudice; it is a pricing strategy.
• Market Demand Curve Example:
  • Given demand curve: q_d = 1000 - 100p
  • Rearranged as: p = 10 - \frac{q}{100}

Revenue Calculations

• Total Revenue: Calculated as TR = p \times q.
• Marginal Revenue: Found through calculus by taking the derivative of total revenue, though the exact calculations are not required for understanding.

Marginal Cost and Equilibrium

• Assumption: Assume constant marginal cost MC = 3.
• Profit Maximization:
  • Quantity produced is where MR = MC.
  • In this case, the price charged is determined by the demand curve, leading to:
  • Price = 6
  • Quantity = 400.
• Comparison with Perfect Competition:
  • In a competitive market, equilibrium occurs where P = MR = MC.
  • Here, price would be 3 with a quantity of 700.

Consumer Surplus and Deadweight Loss

• Consumer Surplus: The difference between what consumers are willing to pay versus what they actually pay.
• Deadweight Loss: Occurs in markets with market power due to underproduction, where potential transactions that benefit both parties do not occur.
  • Represented visually as a triangle in demand-supply graph.

Perfect Price Discrimination

• Definition: A firm charges each customer exactly their willingness to pay, which theoretically eliminates deadweight loss.
• Implications:
  • Total surplus increases, but is all captured by the producer.
  • The firm doesn't need to weigh the output effect against the discount effect since they charge each individual what they would pay rather than discounting.
• Characteristics: Rare in practice but serves as a baseline for understanding price discrimination.

Conditions for Price Discrimination

1. Market Power: The firm must be able to influence prices, which is not possible in perfect competition.
2. No Resale: If products can be resold, price discrimination becomes ineffective since cheaper products can be resold to higher-paying customers.
3. Market Segmentation: The ability to segment customers into groups based on willingness to pay, allowing targeted pricing strategies.

Common Examples of Price Discrimination

• Discounts for new customers or specific groups (e.g., seniors, students).
• Dynamic pricing strategies where prices change based on consumer behavior or willingness to pay.
• Varying ticket prices based on age or timing (e.g., cheaper movie tickets for children).
• Different offers for financial aid depending on the student's profile.
• Higher prices for some goods in relation to lower prices for complimentary goods (e.g., cheap movie tickets but higher priced food/drinks).