Lecture 9: Price Discrimination

Loading...

Lecture 9: Price Discrimination EC 105. Industrial Organization. Fall 2011 Matt Shum HSS, California Institute of Technology

September 9, 2011

EC 105. Industrial Organization. Fall 2011 ( Matt Shum HSS, California Lecture Institute 9: Price of Discrimination Technology)

September 9, 2011

1 / 23

Outline

Outline

1

Perfect price discrimination

2

Third-degree price discrimination: “pricing-to-market”

3

Second-degree price discrimination

4

Bundling

5

Durable goods and secondary markets

6

Pharmaceutical pricing after patent expiration

EC 105. Industrial Organization. Fall 2011 ( Matt Shum HSS, California Lecture Institute 9: Price of Discrimination Technology)

September 9, 2011

2 / 23

Outline

Price discrimination

Up to now, consider situations where each firm sets one uniform price Consider cases where firm engages in non-uniform pricing: 1 2

Charging customers different prices for the same product (airline tickets) Charging customers a price depending on the quantity purchased (electricity, telephone service)

Consider three types of price discrimination: 1

2

3

Perfect price discrimination: charging each consumer a different price. Often infeasible. Third-degree price discrimination: charging different prices to different groups of customers Second-degree price discrimination: each customer pays her own price, depending on characteristics of purchase (bundling)

Throughout, consider just monopoly firm.

EC 105. Industrial Organization. Fall 2011 ( Matt Shum HSS, California Lecture Institute 9: Price of Discrimination Technology)

September 9, 2011

3 / 23

Perfect price discrimination

Perfect price discrimination (PPD) 1

Graph. Monopolist sells product with downward-sloping demand curve Each consumer demands one unit: demand curve graphs number of consumers against their willingness-to-pay for the product. Perfect price discrimination: charge each consumer her WTP Perfectly discriminating monopolist produces more than “regular” monopolist: both produce at q where MC (q) = MR(q), but for PD monopolist MR(q) = p(q). PD monopolist produces at perfectly competitive outcome where p(q) = MC (q)! Perfectlly discriminating monopolist makes much higher profits (takes away all of the consumer surplus)

EC 105. Industrial Organization. Fall 2011 ( Matt Shum HSS, California Lecture Institute 9: Price of Discrimination Technology)

September 9, 2011

4 / 23

Perfect price discrimination

Perfect price discrimination (PPD) 2 This simple example illustrates: Profit motive for price discrimination In order for PPD to work, assume consumers can’t trade with each other: no resale condition. With resale, marginal customer buys for whole market. Equivalent to assuming that monopolist knows the WTP of each consumer: if consumers could lie, same effect as resale (everybody underreports their WTP: public goods problem). Purchase constraints also prevent resale and support price discrimination: limit two per customer sales?

Lower consumer welfare (no consumer surplus under PPD) but high output. When consumers demand more than one unit, but have varying WTP for each unit, firm may offer price schedules or quantity discounts (example: electricity, telephone pricing, TTC tokens) Next: focus on models where monopolist doesn’t know the WTP of each consumer.

EC 105. Industrial Organization. Fall 2011 ( Matt Shum HSS, California Lecture Institute 9: Price of Discrimination Technology)

September 9, 2011

5 / 23

Third-degree price discrimination: “pricing-to-market”

3rd-degree price discrimination (3PD) 1

Monopolist only knows demand functions for different groups of consumers (graph): groups differ in their price responsiveness Cannot distinguish between consumers in each group (ie., resale possible within groups, not across groups) Student vs. Adult tickets Journal subscriptions: personal vs. institutional Gasoline prices: urgent vs. non-urgent

Main ideas: under optimal 3PD— 1

2

Charge different price to different group, according to inverse-elasticity rule. Group with more elastic demand gets lower price. Can increase consumer welfare: group with more elastic demand gets lower price under 3PD.

EC 105. Industrial Organization. Fall 2011 ( Matt Shum HSS, California Lecture Institute 9: Price of Discrimination Technology)

September 9, 2011

6 / 23

Third-degree price discrimination: “pricing-to-market”

3rd-degree price discrimination (3PD) 2

Consider two groups of customers, with demand functions group 1: q1 = 5 − p group 2: q2 = 5 − 2 ∗ p (graph) Assume: monopolist produces at zero costs

EC 105. Industrial Organization. Fall 2011 ( Matt Shum HSS, California Lecture Institute 9: Price of Discrimination Technology)

September 9, 2011

7 / 23

Third-degree price discrimination: “pricing-to-market”

3rd-degree price discrimination (3PD) 3

If monopolist price-discriminates: maxp1 ,p2 p1 ∗ (5 − p1 ) + p2 ∗ (5 − 2 ∗ p2 ). Given independent demands, solves the two problems separately. graph p1PD =

5 2

p2PD =

5 4

q1PD =

5 2

q2PD =

5 2

CS1PD = π1PD =

25 8

25 4

CS2PD = π2PD =

25 16

25 8

Compare with outcome when monopolist cannot price-discriminate.

EC 105. Industrial Organization. Fall 2011 ( Matt Shum HSS, California Lecture Institute 9: Price of Discrimination Technology)

September 9, 2011

8 / 23

Third-degree price discrimination: “pricing-to-market”

3rd-degree price discrimination (3PD) 3

If monopolist doesn’t price-discriminate (uniform pricing): maxp π m = p ∗ (5 + 5 − (1 + 2) ∗ p) = p ∗ (10 − 3p) p1M =

5 3

p2M =

5 3

q1M =

10 3

q2M =

5 3

CS1M = π1M =

50 9

50 9

CS2M = π2M =

EC 105. Industrial Organization. Fall 2011 ( Matt Shum HSS, California Lecture Institute 9: Price of Discrimination Technology)

25 36

25 9

September 9, 2011

9 / 23

Third-degree price discrimination: “pricing-to-market”

3rd-degree price-discrimination (3PD) 4 Effects of 3PD: 3PD affects distribution of income: higher price (lower demand) for group 1, lower price (higher demand) for group 2, relative to uniform price scheme Total production is same (5) under both scenarios (specific to this case). In general, if total output higher under 3PD, increases welfare in economy. Higher profits for monopolist under 3PD (always true: if he can 3PD, he can make at least as much as when he cannot) Compare per-unit consumer welfare (CS/q) for each group under two scenarios: 5 (CS/q)M 1 = 3 = 1.67 PD (CS/q)1 = 54 = 1.25

(CS/q)M 2 = (CS/q)M 2 =

5 12 = 0.42 5 8 = 0.625

Group 2 gains; group 1 loses Compare weighted average of (CS/q) under two regimes: 1 2

CS1 +CS2 q1 +q2

without PD: 1.25 with PD: 1.5625

Average consumer welfare higher under 3PD: specific to this model EC 105. Industrial Organization. Fall 2011 ( Matt Shum HSS, California Lecture Institute 9: Price of Discrimination Technology)

September 9, 2011

10 / 23

Third-degree price discrimination: “pricing-to-market”

3rd-degree price discrimination (3PD) 5 In general, price-discriminating monopolist follows inverse elasticity rule with respect to each group: (pi − MC (qi )) 1 =− pi i or (assuming constant marginal costs) 1+ pi = pj 1+

1 j 1 i

This is the “Ramsey pricing rule”: (roughtly speaking) consumers with less-elastic demands should be charged higher price Senior discounts Food at airports, ballparks, concerts Optimal taxation Caveat: this condition is satisfies only at optimal prices (and elasticity is usually a function of price) EC 105. Industrial Organization. Fall 2011 ( Matt Shum HSS, California Lecture Institute 9: Price of Discrimination Technology)

September 9, 2011

11 / 23

Second-degree price discrimination

2nd-degree price discrimination 1

Firm charges different price depending on characteristics of the purchase. These characteristics include: Amount purchased (nonlinear pricing). Examples: sizes of grocery products Bundle of products purchased (bundling, tie-ins). Examples: fast-food “combos”, cable TV

Difference with 3rd-degree PD: here, assume that monopolist cannot classify consumers into groups, ie., it knows there are two groups of consumers, but doesn’t know who belongs in what group. Set up a pricing scheme so that each type of consumer buys the amount that it should: rely on consumer “self-selection” Groups, or “types”, of consumers are distinguished by their willingness-to-pay for the firm’s product. Characteristic of purchase is a signal of a consumer’s type. So signal-contingent prices proxy for type-contingent prices.

EC 105. Industrial Organization. Fall 2011 ( Matt Shum HSS, California Lecture Institute 9: Price of Discrimination Technology)

September 9, 2011

12 / 23

Second-degree price discrimination

2nd-degree price discrimination 2 Simple example: airline pricing Assume firm cannot distinguish between business travellers and tourists, but knows that the former are willing to pay much more for 1st-class seats. Formally: firm wants to price according to type (business or tourist) but cannot; therefore it does next best thing: set prices for 1st-class and coach seats so that consumers “self-select”. Airline chooses prices of first-class (pF ) vs. coach fares (pC ). such that business travellers choose first-class seats and tourists choose coach seats. This entails: 1

2

Ensuring that each type of traveller prefers his “allocated” seat (self-selection constraints): uB (first class) − pF > uB (coach) − pC

(1)

uT (coach) − pC > uT (first class) − pF

(2)

Ensuring that uB (first class) − pF > 0, and uT (coach) − pC > 0, so that both types of travellers prefer travelling to not: participation constraints

EC 105. Industrial Organization. Fall 2011 ( Matt Shum HSS, California Lecture Institute 9: Price of Discrimination Technology)

September 9, 2011

13 / 23

Second-degree price discrimination

2nd-degree price discrimination 3 Airline pricing example: add some numbers 2 travellers, one is business (B), and one is tourist (T), but monopolist doesn’t know which. Plane has one first-class seat, and one coach seat. uB (F) = 1000 uB (C) = 400 uT (F) = 500 uT (C) = 300 If firm knew each traveller’s type, charge pC = 300, and pF = 1000. But doesn’t know type, so set pC , pF , subject to: 1000 − pF ≥ 400 − pC Type B buys first class

(3)

300 − pC ≥ 500 − pF Type T buys coach

(4)

1000 − pF ≥ 0 Type B decides to travel

(5)

300 − pC ≥ 0 Type T decides to travel

(6)

EC 105. Industrial Organization. Fall 2011 ( Matt Shum HSS, California Lecture Institute 9: Price of Discrimination Technology)

September 9, 2011

14 / 23

Second-degree price discrimination

2nd-degree price discrimination 4

Solution to airline pricing example Charge pC = 300. Any higher would violate (6), and any lower would not be profit-maximizing. If charge pF = 1000, type B prefers coach seat: violate constraint (3). By constraint (3), type B must receive net utility from first-class of at least 100, which he would get from purchasing coach at price of 300. Thus upper bound on pF is 900, which leaves him with net utility=100. Lower bound on pF is 500, to prevent type T from prefering first-class. To maximize profits, charge the upper bound pF = 900.

EC 105. Industrial Organization. Fall 2011 ( Matt Shum HSS, California Lecture Institute 9: Price of Discrimination Technology)

September 9, 2011

15 / 23

Second-degree price discrimination

2nd-degree price discrimination 5

In general: pC = uB (C): Charge “low demand” types their valuation (leaving them with zero net utility) pF = uF (F) − (uF (C) − pC ): Charge “high demand” types just enough to make them indifferent with the two options, given that “low demand” receive zero net utility. At optimal prices, only constraints 1 and 4 are binding: participation constraint for low type, and self-selection constraint for the high type =⇒ make low type indifferent between buying or not, and make high type indifferent between the “high” and “low” products General principle which holds when more than 2 types See this in next lecture.

EC 105. Industrial Organization. Fall 2011 ( Matt Shum HSS, California Lecture Institute 9: Price of Discrimination Technology)

September 9, 2011

16 / 23

Bundling

Bundling: indirect price discrimination Indirect price discrimination is pervasive, and many market institutions can be interpreted in this light. Stigler: Block booking Monopoly offers two movies: Gone with the Wind and Getting Gertie’s Garter. There are movie theaters with “high” and “low” WTP for each movie: Theater WTP for GWW WTP for GGG A 8000 2500 B 7000 3000 Specific assumption about preferences: Theater A is “high” for GWW, and “low” for GGG. Theater B is “low” for GWW and “high” for GGG −→ preferences for the two products are negatively correlated Monopolist would like to charge each theater a different price for GWW (same with GGG), but that is against the law. Question: does bundling the movies together allow you to price discriminate? EC 105. Industrial Organization. Fall 2011 ( Matt Shum HSS, California Lecture Institute 9: Price of Discrimination Technology)

September 9, 2011

17 / 23

Bundling

Bundling 2

Without bundling, monopolist charges 7000 = min(8000, 7000) for GWW and 2500 = min(2500, 3000) for GGG. Total profits: 2 ∗ (7000 + 2500) = 19500. With bundling, monopolist charges 10000 = min(8000 + 2500, 7000 + 3000) for the bundle: profits = 2*10000 (higher) What about price discrimination? Akin to charging theater B 7000 and 3000 for GWW and GGG, and theater A 8000 and 2000. This will not work if preferences are not negatively correlated: Theater WTP for GWW WTP for GGG A 8000 2500 B 7000 1500 With or without bundling, preferences of theater B (low type) dictate market prices.

EC 105. Industrial Organization. Fall 2011 ( Matt Shum HSS, California Lecture Institute 9: Price of Discrimination Technology)

September 9, 2011

18 / 23

Bundling

Also will not work if “extremely” negatively correlated: Theater WTP for GWW WTP for GGG A 8000 10 B 20 4000 Here, monopolist maximizes profits by just selling GWW to A, and GGG to B: need one product to be “better” than other (cable TV bundling?) More generally, (this view of) bundling illustrates other methods of indirect price discrimination

EC 105. Industrial Organization. Fall 2011 ( Matt Shum HSS, California Lecture Institute 9: Price of Discrimination Technology)

September 9, 2011

19 / 23

Durable goods and secondary markets

Other examples

Consider a simple durable goods market: cars live two periods (new/used) Consumer type WTP for new WTP for old Hi 8000 2000 Low 3000 3000 Without secondary markets, consumers can only buy new cars, and hold onto them for two periods. Pricing without secondary markets? Pricing with secondary markets?

EC 105. Industrial Organization. Fall 2011 ( Matt Shum HSS, California Lecture Institute 9: Price of Discrimination Technology)

September 9, 2011

20 / 23

Pharmaceutical pricing after patent expiration

Pharmaceutical pricing after patent expiration 84

Journal of Economics & Management Strategy

FIGURE 2. Generic Entry and the Pricing of Pharmaceuticals

83

FIGURE 1.

EC 105. Industrial Organization. Fall 2011 ( Matt Shum HSS, California Lecture Institute 9: Price of Discrimination Technology)

FIGURE 3.

September 9, 2011

21 / 23

Pharmaceutical pricing after patent expiration

Pharmaceutical pricing after patent expiration

87

Generic Entry and the Pricing of Pharmaceuticals Table III.

Brand-Name Price Regressiona Variable NMFT NMFTHAT Constant N a b c

Fixed Effects

TS Fixed Effectsb

TS Fixed Effectsc

0.007 (2.25) — — �1.487 (101.97) 343

— — 0.011 (2.97) �1.479 (95.12) 179

— — 0.016 (3.96) �1.486 (101.38) 179

Dependent variable: P B (t statistics in parentheses). First-stage fixed-effects model (column 1 of Table II) First-stage variance components with time trend (column 2 of Table II)

What is going on? number of competitors. The parameter estimate suggests that each new entrant is associated with roughly a 0.7% rise in the brand-name price. The estimated models reported in the second and third columns of Table III each treat the number of competitors as endogenous. Recall that our two-stage estimators rely on rather strong assumptions about the information accounted for by the time trend measured by the time since patent expiration and the demand for brand-name drugs. For this reason the results reported below should be interpreted The EC 105. Industrial Organization. Fall 2011 ( Matt Shum HSS, California Lecture Institute 9: cautiously. Price of Discrimination Technology)

September 9, 2011

22 / 23

Pharmaceutical pricing after patent expiration

Conclusions

Perfect PD: monopolist gets higher profits, consumers pay more 3rd-degree PD: monopolist gets high profits, but possible that consumers are better off. 2nd-degree PD: used when monopolist cannot distinguish between different types of consumers. Indirect price discrimination

EC 105. Industrial Organization. Fall 2011 ( Matt Shum HSS, California Lecture Institute 9: Price of Discrimination Technology)

September 9, 2011

23 / 23

Loading...

Lecture 9: Price Discrimination

Lecture 9: Price Discrimination EC 105. Industrial Organization. Fall 2011 Matt Shum HSS, California Institute of Technology September 9, 2011 EC 10...

312KB Sizes 6 Downloads 8 Views

Recommend Documents

Price strategy & price discrimination - SlideShare
Aug 19, 2012 - A seller can earn greater profit through price discrimination than through charging one price from the wh

Price Discrimination | Economics Help
This involves charging a different price to different groups of people for the same good. For example – student discou

Price discrimination - Wikipedia
Price discrimination is a microeconomic pricing strategy where identical or largely similar goods or services are transa

Price Discrimination and Monopoly - WikiEducator
Apr 22, 2012 - Discrimination on the basis of Age, Sex and Status: Here different prices are charged on the basis of age

Marketing Aptitude: Price Discrimination - General Knowledge Today
Aug 23, 2016 - Price Discriminationaccording to facilities: When different prices are charged from different consumers o

Free price discrimination Essays and Papers - 123HelpMe.com
Free price discrimination papers, essays, and research papers. ... Immediately after the Second World War, the newly nat

Lecture 9 Notes
Biology 1B—Evolution Lecture 9 - Speciation Processes. Species identification - the grey zone… Figure 1. Consider th

Lecture 8 and 9
valence electrons. Buried, next to nucleus does not participate in bonding. Remember effective nuclear charge increases

Indian Railways | Price Discrimination | Monopoly - Scribd
About Indian Railways. Indian Railways (IR) is a national asset as a single transport network which connects far flung a

Price Discrimination in Marketing Management - IIBM LMS
Many companies sell the same product or service to different customer groups at different prices. Price discrimination e