MANAGERIAL ECONOMICS: PGP 2020

SESSION 16:
PRICE DISCRIMINATION
1
MARKET STRUCTURE

2
 MARKET STRUCTURE

• Once the relevant market has been defined,

to understand the affect an anti competitive
practice one has to look at the “degree of
competitiveness”

3
MEASURING MARKET
CONCENTRATION

4
Indian Automobile Industry
 CONCENTRATION INDEX
• How to measure market concentration in an
industry?

6
 CONCENTRATION RATIO
1. m- Firm Concentration Ratio

Sum total of share of total industry sales

accounted by m largest firms

7
1. m-Firm Concentration Ratio
Firm Industry X Industry Y
1 20 60
2 20 10
3 20 5
4 20 5
5 20 5
5- Firm Concentration 100 85
Ratio

8
 n Firm Concentration Ratio
• n Firm concentration ratio, is the cumulative
market share of top n firms in the industry

• Larger n Firm concentration ratio, greater

domination by top n firms in the industry

• Does n firm concentration ratio have any

drawback?
4-Firm Concentration Ratio
Firm Industry X Industry Y
1 20 60
2 20 10
3 20 5
4 20 5
5 20 5
4 Firm Concentration 80 80
Ratio

10
 n Firm Concentration Ratio
• Fail to recognize the variability among market
shares in the industry
2. Herfindahl and Hirschman Index
• Weighted average of market shares of firms

• Extremely large market shares relative to the

rest of the industry should account for more in
measure of concentration.
• An industry with only one firm will have HHI
index of 10,000
12
4-Firm Concentration Ratio
Firm Industry X Industry Y
1 20 60
2 20 10
3 20 5
4 20 5
5 20 5
4 Firm Concentration 80 80
Ratio
HHI 2,000 3,850

13
 Mergers and HHI
HHI Market Structure

Less than 1,000 Competitive Market Structure

1,000-1,800 Moderately concentrated market

structure

Above 1,800 Highly concentrated

SOCIAL COST OF MONOPOLY

15
16
17
18
19
20
21
22
PRICE DISCRIMINATION
23
 Variable Price Coke Machine
• Coke’s vending machine to charge different
prices based on temperature

• Prices would change based on the stock

available in the vending machine

• Is this fair?
 Have a Coke,
and Big Brother is Sure to Smile
• Why do airlines charge different prices for the
same “product”?

• Why does it cost higher to purchase coke in a

movie theater than outside?

• Is Coke’s pricing technique any different from

these?
PRICE DISCRIMINATION

26
 Price Discrimination

Strategy of

charging different prices for the same (or

similar) product to same or different consumers

when price differences not justified by the cost

differences
 Response to Coke’s Strategy
“Cynical ploy to exploit the thirst”
(San Francisco Chronicle)

“Soda Jerks”
(Miami Herald)

“Latest evidence that world is going to hell in a

handbasket”
(Philadelphia Inquirer)
 Coke’s Response
STATEMENT ON VENDING MACHINE TECHNOLOGY

Atlanta , October 28, 1999: Contrary to some erroneous press

reports , The Coca Cola company is not introducing vending
machines that would raise the price of soft drinks in hot
weather

We are exploring innovative technology and communication

systems that can actually improve product availability ,
promotional activity and even offer consumers interactive
experience when they purchase a soft drink from a vending
machine

Source: Coca Cola’s New Vending Machine (A): Pricing to

Capture Value or Not?, Harvard Business Review
PRICE DISCRIMINATION

30
Everywhere
 Examples
• Geography
• Time
- Airline/ Movie Tickets prices:
(Holiday/ Non Holiday season) (weekends/
weekdays)
- Dinner prices different
• Age/Gender
 PEAK LOAD PRICING
kWh Cents/kWh kWh Cents/kWh

Residential Rates, 0-250 kWh (single residence)

June- 0-250 7.212 Above 250 8.349
September
Other Months 0-250 7.212 Above 250 7.212
Commercial Rates, 0-2,000 kWh (small business)
June- 0-2,000 9.28 Above 2,000 4.76
September

Other Months 0-2,000 7.86 Above 2,000 3.22

WHAT IS NOT PRICE
DISCRIMINATION?

34
 Price Discrimination

Price difference must NOT be based on cost

differences
 Price Discrimination
• Hardcover book costs : Rs 2,000
• Paper back book costs : Rs 1,000

• If the cost difference of making a hardcover

book as opposed to paperback book is
justified by the price => NOT PRICE
DISCRIMINATION
 Price Discrimination
• Business class ticket : Rs 4 lakh
• Economy class ticket: Rs 1 lakh

• If it costs less than Rs 3 lakhs to give additional

services of business class => PRICE
DISCRIMINATION
CONDITIONS FOR PRICE
DISCRIMINATION
 Requirement 1
• What is the primary condition for Price
Discrimination?

• Is it possible for the firm to discriminate if it

has no monopoly power?

• Monopoly Power: Firm must have some

control over the product
 Monopoly Power
• Without monopoly power, no firm can
exercise any control over prices.

• Without any control over prices, there is no

possibility of PRICE DISCRIMINATION
 Requirements
• Is Monopoly Power enough?

• Would you be able to charge different prices

to your customers if the customers were
identical?
 Requirement 2

Heterogeneous Customers:
Price elasticity of demand for the product
must differ for different quantities/times/
markets
 Requirements
• Is Monopoly Power enough?

• Having a heterogeneous customer base

enough?

• What if customers in one segment sold the

product to ones in another segment?
 Requirement 3:

No ARBITRAGE:
In ability of the consumers charged a lower
price to sell the same product to ones charged
a higher price
 Requirements
1. Monopoly Power

2. Heterogeneous Consumers

3. No Arbitrage
TYPES OF PRICE DISCRIMINATION

46
COUPONS

47
 Coupons
• Why do firms offer coupons?

• What are the different types of coupons?

48
Types of Coupons
SECOND DEGREE
PRICE DISCRIMINATION
(INDIRECT PRICE DISCRIMINATION)

50
Second Degree Price Discrimination

Practice of charging different prices per unit for

different quantities of the same good or service.
Second Degree Price Discrimination
• Each customer faces same price schedule but
pays different prices based on quantity
purchased.

• Example is quantity discounts: A family pack of

soap powder or biscuits tend to cost less per
kg than smaller packs.
 Types of Price Discrimination

• Indirect Price Discrimination:

Based on unobservable characteristics
Consumers self select themselves

• Direct Price Discrimination:

Based on observable characteristics
THIRD DEGREE
PRICE DISCRIMINATION
(DIRECT PRICE DISCRIMINATION)

54
Third Degree Price Discrimination
 Price Discrimination
• Divide the group in to more than two
segments

• Segments should be different in the elasticity

of demand for the product

• Determine price of the product in the

segments
 Inter temporal
Price Discrimination
$/Q
Initially, demand is less Over time, demand becomes
elastic, resulting in a more elastic and price
P1 price of P1 . is reduced to appeal to the
mass market.

P2
D2 = AR2

AC = MC

MR2
MR1 D1 = AR1

Q1 Q2 Quantity
57
 PRICE DISCRIMINATION
Third-Degree Price Discrimination
Creating Consumer Groups

Determining Relative Prices

FIRST DEGREE
PRICE DISCRIMINATION

59
 First Degree Price Discrimination
If you knew the demand function of consumers,
how would you price the consumers?
First Degree Price Discrimination
• What would you do to extract all the consumer
surplus?
• Charge a separate price to each customer/ for
each quantity

• What would that price be?

• Charge the maximum or reservation price they
are willing to pay
61
Capturing Consumer Surplus
$/Q The firm would like to
charge higher price to
Pmax those consumers willing
A to pay it - A
P1 Firm would also like to sell
to those in area B but
P* B without lowering price to all
consumers
P2
MC Both ways will allow
the firm to capture
PC more consumer
surplus
D

Q* MR Quantity
62
First Degree Price Discrimination

Quantity Marginal Utility/

Max. Willingness To Pay

1 10

2 9

3 8

4 7

5 6
First Degree Price Discrimination

Quantity Marginal Utility/ Total Revenue (First Marginal Revenue

Max. Willingness Degree Price
To Pay/ Price Discrimination)
1 10 10 -
2 9 10+ 9 9
3 8 10+9+8 8
4 7 10+9+8+7 7
5 6 10+9+8+7+ 6 6
 First Degree Price Discrimination
• Marginal Revenue in FSPD is same as demand
curve

• What would be the optimal quantity chosen if

Marginal Cost is 6?

• How does it compare with that under Perfect

Competition and Monopoly?
Capturing Consumer Surplus
$/Q The firm would like to
charge higher price to
Pmax those consumers willing
A to pay it - A
P1 Firm would also like to sell
to those in area B but
P* B without lowering price to all
consumers
P2
MC Both ways will allow
the firm to capture
PC more consumer
surplus
D

Q* MR Quantity
66
First Degree Price Discrimination v/s
Perfect Competition
Quantity produced in both cases is the same

Perfect Competition:
Profits= 0
Consumer Surplus =

First Degree Price Discrimination:

Profits =
Consumer Surplus = 0
 First Degree Price Discrimination

• Firms usually don’t know the reservation

price of every consumer

• Impractical to charge each and every

customer a different price (unless there are
only a few customers)

• In practice, perfect first-degree price

discrimination is almost never possible.
 Think, Pair and Share
• As a manager of Airtel, you are in charge of
pricing. You have to decide different ways in
which you can charge the customers.

• If you knew your customer very well, what

pricing technique would you use to maximize
your profits?
 Two-Part Tariff
Two Part Tariff: Entry Fee (right to use and buy
the product) and Usage fee

Eg: amusement park, golf course, telephone

service

70
Cellular Rate Plans

71
 The Two-Part Tariff
• Pricing decision is setting the entry fee (T) and
the usage fee (P)

• Single Consumer
– Assume firm knows consumer demand
– Firm wants to capture as much consumer surplus
as possible

72
Two-Part Tariff with a Single Consumer
$/Q

MC
P*

Quantity
73
Two-Part Tariff with a Single Consumer
$/Q Usage price P* is set equal to MC.
Entry price T* is equal to the entire
T* consumer surplus.
Firm captures all consumer surplus
as profit.

MC
P*

Quantity
74
 Take Aways
• Price Discrimination possible on observables
and un-observables

• 3 Necessary conditions to price discriminate

• Higher elasticity of demand, lower price

• Peak Load Pricing, Inter temporal Pricing
• Two Part Tariff