Elasticity, Price Rigidity & Price Discrimination – Comprehensive Lecture Notes

Elastic demand zone
- Defined where price elasticity of demand $|E_d| > 1$ (upper half of a linear demand curve).
- If a firm discovers it is in this zone, lowering price increases total revenue (TR) because the percentage increase in quantity demanded outweighs the percentage fall in price.
- Total revenue identity: $TR = P \times Q$ .
- At the midpoint of a straight‐line demand curve (where $|E_d| = 1$ ) TR is maximised; above that point (elastic region) a price cut pushes you “toward the midpoint,” raising TR.
Competitive interaction caveat
- In reality, rival firms often match price cuts/ rises.
- If a firm raises price while competitors do not, its own product becomes relatively expensive, demand faced becomes more elastic than initially estimated.
- Conversely, if rivals also raise price, demand may be less elastic than thought.

Lecturer sketches a kinked demand curve intuition:
- Upper segment: relatively elastic (firm reluctant to raise price— loses customers).
- Lower segment: relatively inelastic (competitors follow price cuts, so gains in Q are small).
Implication: Profit-maximising oligopolists are resistant to changing price even if costs or market conditions move— explains observed price rigidity.

Assume only two discrete consumer groups to make analysis tractable:
1. High-demand / low‐elasticity consumers (high willingness to pay).
2. Low-demand / high‐elasticity consumers (low willingness to pay).
Pricing question: Which group gets the higher price? → The low‐elasticity (high WTP) group, because demand is less sensitive to price.

Market power: Firm must face a downward-sloping demand curve.
Identifiable sub-markets: Ability to distinguish consumer types (directly or indirectly).
No (or costly) resale/ arbitrage between sub-markets — prevents low‐price buyers selling to high‐price buyers.
- Services frequently satisfy this better than physical goods (harder to resell a haircut than a bottle of shampoo).

Also called personalised pricing.
Firm charges each individual exactly their maximum willingness to pay (reservation price).
Graphically:
- Demand curve = marginal benefit curve.
- Price on each unit equals height of demand curve.
- Profit (producer surplus) captures entire area under demand curve above marginal cost (MC) – eliminates all consumer surplus.
- Output expands to point where $P = MC$ (efficient output, unlike monopoly without PD).
Firms attempt approximations using data analytics:
- Optometrists adjusting lens prices after gauging buyer’s reactions.
- Amazon varying book prices by tracking browsing & purchase history; demographics (age, gender) help refine willingness to pay.
Privacy & ethics: Consumers may unwittingly enable higher personalised prices when they overshare information.

Firm sets different uniform prices to recognisable groups; each group still pays one price.
Profit-maximisation condition: $MR<em>1 = MR</em>2 = MC$ across segments (subscript denotes group).

Preconditions: Firm can verify group membership.
Examples:
- Movie tickets cheaper for students/ seniors (ID cards verify).
- Delta Airlines charging higher fares to its own frequent fliers:
- Frequent fliers accumulate Delta miles → regard other carriers as poorer substitutes → demand is less elastic → higher optimal price.
- Income effect logic: lower-income buyers often receive lower prices because any given expenditure forms a larger income share → higher price elasticity.

Firm cannot directly observe type but designs a “menu” so consumers sort themselves.
Mechanism: Options differ along price–quality, price–flexibility, or price–time trade-offs.
Examples:
- Airline fare classes:
- Advance, non-refundable, no-bag tickets vs flexible, refundable ones.
- Friday-out/Monday-back itineraries indicate leisure vs business.
- Amazon’s Super Saver Shipping: cheaper shipping in exchange for slower delivery; attracts price-sensitive, patient buyers.
Design principle: Option attractive to elastic customers offers low price but imposes non-monetary “costs” (inconvenience, risk, delay) the inelastic customers will avoid.

Firm produces multiple versions that cost nearly the same to make but are priced differently.
Examples:
- Software with disabled features (Basic vs Pro).
- Pink tax: identical product made in pink version priced higher because some consumers (often female) value that colour more → lower elasticity.
- Uniforms/ sports jerseys: US vs NZ online stores charging different country-specific prices; website geoblocking prevents cross-market resale.

Also called temporal pricing or sequential skimming.
Firm lowers price over time to capture surplus from impatient (inelastic) consumers first, then from more patient (elastic) ones.
Common settings:
- Fashion collections: full price at season launch → discounted end-of-season → clearance after season.
- Books: hardback (high price) released first, paperback (lower price) later; production cost difference ≈ cost of hard cover, yet large price gap.
- Sales & coupons: price-sensitive shoppers wait/collect coupons; impatient pay list price.

Once aware, students should look for:
- Same good/service sold at different prices not explained by cost differences.
- Restrictions on transfer/ resale (non-transferable tickets, personalised barcodes).
- Requirement of IDs, memberships, or log-ins (enables segmentation).
- Timed price drops, coupons, or shipping choices signalling self-selection mechanisms.

Link to monopoly & marginal revenue: With perfect PD, firm no longer needs MR curve— simply sells until $P=MC$ . With third-degree PD, separate MR curves exist for each segment.
Equity concerns: PD can shift surplus from consumers to producers; but may expand output, lowering deadweight loss (welfare trade-off).
Regulation & ethics: Data privacy rules (e.g., GDPR) and fair-trading regulations may limit discriminatory practices, but many forms remain legal.
Strategic behavior: Consumers may employ VPNs, arbitrage, or delay purchases to defeat PD; firms respond by strengthening sub-market barriers.

Elastic demand ⇒ lower price → higher TR.
Oligopoly kinked demand explains price stickiness.
Price discrimination requires market power, identification, & no resale.
First-degree (personalised), second-degree (menu/ versioning), third-degree (group) frameworks.
Intertemporal PD captures surplus across time.
Real-world markers: student discounts, fare classes, software tiers, pink tax, fashion markdowns, hardback → paperback cycles.