Industrial Organization

CLEF-Unibo

Price Discrimination

Giacomo Calzolari
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 Introduction

• Prescription drugs are cheaper in Canada than the

United States
• Textbooks are generally cheaper in Britain than the
United States
• Examples of price discrimination
– presumably profitable
– should affect market efficiency: not necessarily adversely
– is price discrimination necessarily bad – even if not seen as
“fair”?

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 Feasibility of price discrimination

• Two problems confront a firm wishing to price

discriminate
– identification: the firm is able to identify demands of different
types of consumer or in separate markets
• easier in some markets than others: e.g tax consultants, doctors
– arbitrage: prevent consumers who are charged a low price from
reselling to consumers who are charged a high price
• prevent re-importation of prescription drugs to the United States
• The firm then must choose the type of price
discrimination
– first-degree or personalized pricing
– second-degree or menu pricing
– third-degree or group pricing

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 Third-degree price discrimination

• Consumers differ by some observable characteristic(s)

• A uniform price is charged to all consumers in a
particular group – linear price
• Different uniform prices are charged to different groups
– “kids are free”
– subscriptions to professional journals e.g. American Economic
Review
– airlines
• the number of different economy fares charged can be very large
indeed!
– early-bird specials; first-runs of movies

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 Third-degree price discrimination 2

• The pricing rule is very simple:

– consumers with low elasticity of demand should be
charged a high price
– consumers with high elasticity of demand should be
charged a low price

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 Third degree price discrimination:
example

• Harry Potter volume sold in the United States and Europe

• Demand:
– United States: PU = 36 – 4QU
– Europe: PE = 24 – 4QE
• Marginal cost constant in each market
– MC = $4

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 The example: no price discrimination

• Suppose that the same price is charged in both markets

• Use the following procedure:
– calculate aggregate demand in the two markets
– identify marginal revenue for that aggregate demand
– equate marginal revenue with marginal cost to identify the
profit maximizing quantity
– identify the market clearing price from the aggregate demand
– calculate demands in the individual markets from the
individual market demand curves and the equilibrium price

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 The example (npd cont.)

United States: PU = 36 – 4QU Invert this: At these prices

only the US
QU = 9 – P/4 for P < $36 market is active
Europe: PU = 24 – 4QE Invert
QE = 6 – P/4 for P < $24
Aggregate these demands
Q = QU + QE = 9 – P/4 for $24 < P < $36
Q = QU + QE = 15 – P/2 for P < $24

Now both
markets are
active

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 The example (npd cont.)

Invert the direct demands $/unit

P = 36 – 4Q for Q < 3 36

P = 30 – 2Q for Q > 3
30
Marginal revenue is
MR = 36 – 8Q for Q < 3 17

MR = 30 – 4Q for Q < 3
MR Demand
Set MR = MC MC

Q = 6.5
6.5 15
Quantity

Price from the demand curve P = $17

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 The example (npd cont.)

Substitute price into the individual market demand curves:

QU = 9 – P/4 = 9 – 17/4 = 4.75 million
QE = 6 – P/4 = 6 – 17/4 = 1.75 million
Aggregate profit = (17 – 4)x6.5 = $84.5 million

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 The example: price discrimination

• The firm can improve on this outcome

• Check that MR is not equal to MC in both markets
– MR > MC in Europe
– MR < MC in the US
– the firms should transfer some books from the US to Europe
• This requires that different prices be charged in the
two markets
• Procedure:
– take each market separately
– identify equilibrium quantity in each market by equating MR
and MC
– identify the price in each market from market demand

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 The example: price discrimination 2

$/unit
Demand in the US:
36
PU = 36 – 4QU
Marginal revenue:
20

MR = 36 – 8QU Demand
MR
MC = 4 4 MC

Equate MR and MC 4 9
Quantity
QU = 4
Price from the demand curve PU = $20

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 The example: price discrimination 3

$/unit
Demand in the Europe:
24
PE = 24 – 4QU
Marginal revenue:
14

MR = 24 – 8QU Demand
MR
MC = 4 4 MC

Equate MR and MC 2.5 6 Quantity

QE = 2.5
Price from the demand curve PE = $14

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 The example: price discrimination 4

• Aggregate sales are 6.5 million books

– the same as without price discrimination
• Aggregate profit is (20 – 4)x4 + (14 – 4)x2.5 =
$89 million
– $4.5 million greater than without price discrimination

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 No price discrimination: non-constant
cost

• The example assumes constant marginal cost

• How is this affected if MC is non-constant?
– Suppose MC is increasing
• No price discrimination procedure
– Calculate aggregate demand
– Calculate the associated MR
– Equate MR with MC to give aggregate output
– Identify price from aggregate demand
– Identify market demands from individual demand curves

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 The example again

Applying this procedure assuming that MC = 0.75 +

Q/2 gives:
(a) United States (b) Europe (c) Aggregate
Price Price Price
40 40 40

30 30 30
DU
24
20 20 DE 20 D
17 17 17
MR
10 MRU 10 10
MC
MR E

0 0 0
0
4.75 5 10 0 1.75 5 10 0 5 6.5 10 15 20
Quantity Quantity Quantity

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 Price discrimination: non-constant cost

• With price discrimination the procedure is

– Identify marginal revenue in each market
– Aggregate these marginal revenues to give aggregate marginal
revenue
– Equate this MR with MC to give aggregate output
– Identify equilibrium MR from the aggregate MR curve
– Equate this MR with MC in each market to give individual
market quantities
– Identify equilibrium prices from individual market demands

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 The example again

Applying this procedure assuming that MC = 0.75 +

Q/2 gives:
(a) United States (b) Europe (c) Aggregate
Price Price Price
40 40 40

30 30 30
DU

24
20 20 DE 20
17
14 MR
10 MRU 10 10
MC
4 4 MRE 4
0 0 0
0 5 10 0 1.75 5 10 0 5 6.5 10 15 20
Quantity Quantity Quantity

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 Some additional comments

• Suppose that demands are linear

– price discrimination results in the same aggregate
output as no price discrimination
– price discrimination increases profit
• For any demand specifications two rules apply
– marginal revenue must be equalized in each market
– marginal revenue must equal aggregate marginal
cost

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 Price discrimination and elasticity
• Suppose that there are two markets with the same MC
• MR in market i is given by MRi = Pi(1 – 1/hi)
– where hi is (absolute value of) elasticity of demand
• From rule 1 (above Price is lower in the
market with the higher
– MR1 = MR2 demand elasticity

– so P1(1 – 1/h1) = P2(1 – 1/h2) which gives

P1 (1 – 1/2) 12 – 1
= = 12 – 2
P2 (1 – 1/1)

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 Third-degree price discrimination 2
• Often arises when firms sell differentiated products
– hard-back versus paper back books
– first-class versus economy airfare
• Price discrimination exists in these cases when:
– “two varieties of a commodity are sold by the same seller to
two buyers at different net prices, the net price being the price
paid by the buyer corrected for the cost associated with the
product differentiation.” (Phlips)
• The seller needs an easily observable characteristic that
signals willingness to pay
• The seller must be able to prevent arbitrage
– e.g. require a Saturday night stay for a cheap flight

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 Product differentiation and price discrimination

• Suppose that demand in each submarket is Pi = Ai – BiQi

• Assume that marginal cost in each submarket is MCi = ci
• Finally, suppose that consumers in submarket i do not
purchase from submarket j
It is highly unlikely that the
difference in prices will equal the
• Equate marginal revenue with marginal cost in each
difference in marginal costs

submarket

Ai – 2BiQi = ci  Qi = (Ai – ci)/2Bi  Pi = (Ai + ci)/2

 Pi – Pj = (Ai – Aj)/2 + (ci – cj)/2

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 Other mechanisms for price
discrimination
• Impose restrictions on use to control arbitrage
– Saturday night stay
– no changes/alterations
– personal use only (academic journals)
– time of purchase (movies, restaurants)
• “Crimp” the product to make lower quality products
– Mathematica®
– HP printers
• Discrimination by location

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 Discrimination by location
• Suppose demand in two distinct markets is identical
– Pi = A - BQi
• But suppose that there are different marginal costs in
supplying the two markets
– cj = c i + t
• Profit maximizing rule:
– equate MR with MC in each market as before
–  Pi = (A + ci)/2; Pj = (A + ci + t)/2
–  Pj – Pi = t/2  cj – ci
– difference in prices is not the same as the difference in costs

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 Third-degree rice discrimination and
welfare
• Does third-degree price discrimination reduce welfare?
– not the same as being “fair”
– relates solely to efficiency
– so consider impact on total surplus

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 Price discrimination and welfare
Suppose that there are two markets: “weak” and “strong”
The discriminatory The discriminatory
Price Price
price in the weak price in the strong
market is P1 market is P2

D2 The minimum
The maximum The uniform
gain in surplus in price in both MR2 loss of surplus in
the weak market market is P the strong market
D1 U
P2 is L
is G
PU PU
P1
G L
MR1
MC MC

ΔQ1 Quantity ΔQ2 Quantity

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 Price discrimination and welfare
Price Price
Price discrimination
cannot increase
surplus unless it D2
increases aggregate MR2
D1 output P2

PU PU
P1
G L
MR1
MC MC

ΔQ1 Quantity ΔQ2 Quantity

It follows that ΔW < G – L = (PU – MC)ΔQ1 + (PU – MC)ΔQ2

= (PU – MC)(ΔQ1 + ΔQ2)

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 Price discrimination and welfare 2

• Previous analysis assumes that the same markets are

served with and without price discrimination
• This may not be true
– uniform price is affected by demand in “weak” markets
– firm may then prefer not to serve such markets without price
discrimination
– price discrimination may open up weak markets
• The result can be an increase in aggregate output and
an increase in welfare

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 New markets: an example
Demand in “North” is PN = 100 – QN ; in “South” is PS = 100 - QS

Marginal cost to supply either market is $20

North South Aggregate

$/unit $/unit $/unit

100

100
Demand
MC MC MC

MR
Quantity Quantity Quantity

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 New Markets: the example 2
Aggregate demand is P = (1 + )50 – Q/2
Aggregate
provided that both markets are served
$/unit

Equate MR and MC to get equilibrium output

QA = (1 + )50 - 20

Get equilibrium price from aggregate

P
demand P = 35 + 25 Demand
MC

MR
QA Quantity

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 New Markets: the example 3
Aggregate
Now consider the impact of a $/unit
reduction in 
Aggregate demand changes
Marginal revenue changes
PN
It is no longer the case that both
markets are served Demand

MC
The South market is dropped
D'
MR
Price in North is the monopoly
price for that market Quantity
MR'

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 The example again
Previous illustration is too extreme Aggregate

MC cuts MR at two points $/unit

So there are potentially two equilibria with

uniform pricing
At Q1 only North is served at the
monopoly price in North
At Q2 both markets are served at the PN
uniform price PU PU Demand
Switch from Q1 to Q2: MC
decreases profit by the red area
increases profit by the blue area MR

If South demand is “low enough” or MC Q1 Q2 Quantity

“high enough” serve only North

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 Price discrimination and welfare Again
In this case only North is served $/unit Aggregate
with uniform pricing
But MC is less than the reservation
price PR in South
So price discrimination will lead to PN
South being supplied PR
Demand
Price discrimination leaves surplus
MC
unchanged in North
But price discrimination generates profit and
consumer surplus in South MR

Q1 Quantity
So price discrimination increases welfare

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 Price discrimination and welfare One more time

• Suppose only North is served with a uniform price

• Also assume that South will be served with price
discrimination
– Welfare in North is unaffected
– Consumer surplus is created in South: opening of a new market
– Profit is generated in South: otherwise the market is not opened
• As a result price discrimination increases welfare.

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 Price Discrimination and
Monopoly: Nonlinear Pricing

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 Introduction
• Annual subscriptions generally cost less in total than one-off
purchases
• Buying in bulk usually offers a price discount
– these are price discrimination reflecting quantity discounts
– prices are nonlinear, with the unit price dependent upon the quantity
bought
– allows pricing nearer to willingness to pay
– so should be more profitable than third-degree price discrimination
• How to design such pricing schemes?
– depends upon the information available to the seller about buyers
– distinguish first-degree (personalized) and second-degree (menu)
pricing

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 First-degree price discrimination 2

• Monopolist can charge maximum price that each

consumer is willing to pay
• Extracts all consumer surplus
• Since profit is now total surplus, find that first-degree
price discrimination is efficient

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 First-degree price discrimination 3
• Suppose that you own five antique cars
• Market research shows there are collectors of different types
– keenest is willing to pay $10,000 for a car, second keenest $8,000,
third keenest $6,000, fourth keenest $4,000, fifth keenest $2,000
– sell the first car at $10,000
– sell the second car at $8,000
– sell the third car to at $6,000 and so on
– total revenue $30,000
• Contrast with linear pricing: all cars sold at the same price
– set a price of $6,000
– sell three cars
– total revenue $18,000

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 First-degree price discrimination 4

• First-degree price discrimination is highly profitable

but requires
– detailed information
– ability to avoid arbitrage
• Leads to the efficient choice of output: since price
equals marginal revenue and MR = MC
– no value-creating exchanges are missed

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 First-degree price discrimination 5
• The information requirements appear to be
insurmountable
– but not in particular cases
• tax accountants, doctors, students applying to private universities
• No arbitrage is less restrictive but potentially a
problem
• But there are pricing schemes that will achieve the
same outcome
– non-linear prices
– two-part pricing as a particular example of non-linear prices
• charge a quantity-independent fee (membership?) plus a per unit
usage charge
– block pricing is another
• bundle total charge and quantity in a package

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 Two-part pricing

• Jazz club serves two types of customer

– Old: demand for entry plus Qo drinks is P = Vo – Qo
– Young: demand for entry plus Qy drinks is P = Vy – Qy
– Equal numbers of each type
– Assume that Vo > Vy: Old are willing to pay more than
Young
– Cost of operating the jazz club C(Q) = F + cQ
• Demand and costs are all in daily units

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 Two-part pricing 2
• Suppose that the jazz club owner applies “traditional”
linear pricing: free entry and a set price for drinks
– aggregate demand is Q = Qo + Qy = (Vo + Vy) – 2P
– invert to give: P = (Vo + Vy)/2 – Q/2
– MR is then MR = (Vo + Vy)/2 – Q
– equate MR and MC, where MC = c and solve for Q to give
– QU = (Vo + Vy)/2 – c
– substitute into aggregate demand to give the equilibrium price
– PU = (Vo + Vy)/4 + c/2
– each Old consumer buys Qo = (3Vo – Vy)/4 – c/2 drinks
– each Young consumer buys Qy = (3Vy – Vo)/4 – c/2 drinks
– profit from each pair of Old and Young is U = (Vo + Vy – 2c)2

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 Two part pricing 3

This example can be illustrated as follows:

(a) Old Customers (b) Young Customers (c) Old/Young Pair of Customers
Price Price Price

a Vo
Vo

V e
y
d b f Vo+V y + c h i
g 4 2

c k j MC

MR

Vo+V y Vo + Vy
Quantity Vo Quantity Vy - c Quantity
2

Linear pricing leaves each type of consumer with consumer surplus

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 Two part pricing 4
• Jazz club owner can do better than this
• Consumer surplus at the uniform linear price is:
– Old: CSo = (Vo – PU).Qo/2 = (Qo)2/2
– Young: CSy = (Vy – PU).Qy/2 = (Qy)2/2
• So charge an entry fee (just less than):
– Eo = CSo to each Old customer and Ey = CSy to each Young
customer
• check IDs to implement this policy
– each type will still be willing to frequent the club and buy the
equilibrium number of drinks
• So this increases profit by Eo for each Old and Ey for
each Young customer

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 Two part pricing 5

• The jazz club can do even better

– reduce the price per drink
– this increases consumer surplus
– but the additional consumer surplus can be extracted through
a higher entry fee
• Consider the best that the jazz club owner can do with
respect to each type of consumer

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 Two-Part
$/unit Pricing
Vi The entry charge
Set the unit price equal Using two-part
converts consumer
to marginal cost pricing increases
surplus the
into profit
monopolist’s
profit
This gives consumer
surplus of (Vi - c)2/2 c MC
MR
Set the entry charge
to (Vi - c)2/2 Vi - c Vi
Quantity

Profit from each pair of Old and Young now d = [(Vo – c)2 + (Vy – c)2]/2

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 Bundling
● bundling Practice of selling two or more products as a package.

To see how a film company can use customer heterogeneity to its advantage, suppose
that there are two movie theaters and that their reservation prices for our two films are
as follows:

GONE WITH THE WIND GETTING GERTIE’S GARTER

(W) (G)
Theater A $12,000 $3000
Theater B $10,000 $4000

If the films are rented separately, the maximum price that could be charged for Wind is
$10,000 because charging more would exclude Theater B. Similarly, the maximum
price that could be charged for Gertie is $3000.
But suppose the films are bundled. Theater A values the pair of films at $15,000
($12,000 + $3000), and Theater B values the pair at $14,000
($10,000 + $4000). Therefore, we can charge each theater $14,000 for the pair of films
and earn a total revenue of $28,000.
Relative Valuations

Why is bundling more profitable than selling the films separately? Because the
relative valuations of the two films are reversed.
The demands are negatively correlated —the customer willing to pay the most for
Wind is willing to pay the least for Gertie.
Suppose demands were positively correlated—that is, Theater A would pay more for
both films:

GONE WITH THE WIND GETTING GERTIE’S GARTER

Theater A $12,000 $4000
Theater B $10,000 $3000

If we bundled the films, the maximum price that could be charged for the package is
$13,000, yielding a total revenue of $26,000, the same as by renting the films
separately.
RESERVATION PRICES
Reservation prices r1 and r2 for
two goods are shown for three
consumers, labeled A, B, and C.
Consumer A is willing to pay up
to $3.25 for good 1 and up to $6
for good 2.
CONSUMPTION DECISIONS
WHEN PRODUCTS ARE SOLD
SEPARATELY
The reservation prices of consumers
in region I exceed the prices P1 and P2
for the two goods, so these consumers
buy both goods.
Consumers in regions II and IV buy
only one of the goods,
and consumers in region III buy
neither good.
CONSUMPTION DECISIONS
WHEN PRODUCTS ARE
BUNDLED
Consumers compare the sum of their
reservation prices r1 + r2, with the price
of the bundle PB.

They buy the bundle only if r1 + r2 is at

least as large as PB.
RESERVATION PRICES
In (a), because demands are perfectly positively correlated, the firm does
not gain by bundling: It would earn the same profit by selling the goods
separately.
In (b), demands are perfectly negatively correlated. Bundling is the ideal
strategy—all the consumer surplus can be extracted.
BACK TO OUR MOVIE EXAMPLE
Consumers A and B are two movie
theaters. The diagram shows their
reservation prices for the films Gone
with the Wind and Getting Gertie’s
Garter.
Because the demands are negatively
correlated, bundling pays.
Mixed Bundling
● mixed bundling Selling two or more goods both as a package
and individually.

● pure bundling Selling products only as a package.

MIXED VERSUS PURE BUNDLING

With positive marginal costs, mixed
bundling may be more profitable than
pure bundling.
Consumer A has a reservation price
for good 1 that is below marginal cost
c1,
and consumer D has a reservation
price for good 2 that is below
marginal cost c2.

With mixed bundling, consumer A is

induced to buy only good 2, and
consumer D is induced to buy only
good 1, thus reducing the firm’s cost.
Let’s compare three strategies:
1. Selling the goods separately at prices P1 = $50 and P2 = $90.
2. Selling the goods only as a bundle at a price of $100.
3. Mixed bundling, whereby the goods are offered separately at prices
P1 = P2 = $89.95, or as a bundle at a price of $100.

TABLE 11.4 BUNDLING EXAMPLE

P1 P2 P3 PROFIT
Sold separately $50 $90 — $150
Pure bundling — — $100 $200
Mixed bundling $89.95 $89.95 $100 $229.90

As we should expect, pure bundling is better than selling the goods separately because
consumers’ demands are negatively correlated. But what about mixed bundling?
It can be optimal (also with zero marginal costs) simply because demands are not
perfectly correlated.
Bundling in Practice

MIXED BUNDLING IN PRACTICE

The dots in this figure are estimates of
reservation prices for a representative
sample of consumers.
1) A company could first choose a price
for the bundle, PB, such that a diagonal
line connecting these prices passes
roughly midway through the dots.
2) The company could then try individual
prices P1 and P2.

Given P1, P2, and PB, profits can be

calculated for this sample of consumers.
Managers can then raise or lower P1, P2,
and PB and see whether the new pricing
leads to higher profits. This procedure is
repeated until total profit is roughly
maximized.
 Second-degree price discrimination
• What if the seller cannot distinguish between buyers?
– perhaps they differ in income (unobservable)
• Then the type of price discrimination just discussed is
impossible
• High-income buyer will pretend to be a low-income
buyer
– to avoid the high entry price
– to pay the smaller total charge
• Take a specific example
– Ph = 16 – Qh
– Pl = 12 – Ql
– MC = 4

63
 Second-degree price discrimination 2
• First-degree price discrimination requires:
– High Income: entry fee $72 and $4 per drink or entry plus 12
drinks for a total charge of $120
– Low Income: entry fee $32 and $4 per drink or entry plus 8
drinks for total charge of $64
• This will not work
– high income types get no consumer surplus from the package
designed for them but get consumer surplus from the other
package
– so they will pretend to be low income even if this limits the
number of drinks they can buy
• Need to design a “menu” of offerings targeted at the
two types
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 Second-degree price discrimination 3
• The seller has to compromise
• Design a pricing scheme that makes buyers
– reveal their true types
– self-select the quantity/price package designed for them
• Essence of second-degree price discrimination
• It is “like” first-degree price discrimination
– the seller knows that there are buyers of different types
– but the seller is not able to identify the different types
• A two-part tariff is ineffective
– allows deception by buyers
• Use quantity discounting

65
 Second degree price Low
discrimination
income
4
consumers will not
buy the ($88, 12)
High-income Low-Income
package since they
These packages exhibit
This is the incentive are willing
quantity to pay
discounting: high-
So
So will the high- any other
compatibility constraint package
The
only $72low-demand
12 perconsumers
for$7.33 will be
income pay unit and
income
So they be offered
offered ato
canconsumers: high-income
package willing topay
drinks
low-income buy$8this ($64, 8) package
$ because the ($64, 8) -88=32
consumers must
$ ) offer
of ($88, 12)
Profit from(since
High $120
income
each high-consumers are atAnd profit from
16 package
andincome gives
they willconsumer
buy them
this $32
leastto$32
willing
consumer surplus is
payconsumer surplus
up to $120 for each
Offerlow-income
the low-income
entry
$40 ($88 - 12 x $4)plus 12 12
drinks if no otherconsumer
consumersisa package of
$32 package is available $32 ($64 - 8x$4)
entry plus 8 drinks for $64
8
$32
$40 $32
$32
4
$64 $8
$24 MC 4 MC
$32 $16 $32
$8
8 12 16 8 12
Quantity Quantity
66
 The incentive compatibility constraint

• Any offer made to high demand consumers must offer them

as much consumer surplus as they would get from an offer
designed for low-demand consumers.
• This is a common phenomenon
– performance bonuses must encourage effort
– insurance policies need large deductibles to deter cheating
– piece rates in factories have to be accompanied by strict quality
inspection
– encouragement to buy in bulk must offer a price discount

67
 Second degree price discrimination 5
A high-income consumer will pay
up to $87.50 for entry and 7
drinks High-Income Low-Income
So buying the ($59.50, 7) package Suppose each low-income
gives him $28 consumer surplus Can the club-
consumer is offered 7 drinks
The
So entry plus monopolist
12 drinks ownerbetter
does
can be sold doEach
even
byconsumer will pay up to
$ for $92 ($120 - 28 = $92) $ betterof
16
reducing the number than this?
units
$59.50 for entry and 7 drinks
offered to low-income Yes! Reduce
Profit
consumers the number
from each ($59.50, 7)
12 ofpackage
units offered to each
is $31.50: a reduction
since this allows him to low-income
increase
of $0.50 perconsumer
consumer
$28
the charge to high-income
$87.50
$44$92 consumers $31.50
$59.50
4 MC 4 MC
$28$48 $28

7 12 16 78 12
Quantity Quantity
Profit from each ($92, 12)
package is $44: an increase of $4 68
per consumer
 Second-degree price discrimination 6

• Will the monopolist always want to supply both types

of consumer?
• There are cases where it is better to supply only high-
demand types
– high-class restaurants
– golf and country clubs
• Take our example again
– suppose that there are Nl low-income consumers
– and Nh high-income consumers

69
 Second-degree price discrimination 7

• Suppose both types of consumer are served

– two packages are offered ($57.50, 7) aimed at low-income and
($92, 12) aimed at high-income
– profit is $31.50xNl + $44xNh
• Now suppose only high-income consumers are served
– then a ($120, 12) package can be offered
– profit is $72xNh
• Is it profitable to serve both types?
– Only if $31.50xNl + $44xNh > $72xNh  31.50Nl > 28Nh
This requires that Nh
< 31.50 = 1.125
Nl 28
There should not be “too high” a fraction of high-demand consumers

70
 Second-degree price discrimination 8
• Characteristics of second-degree price discrimination
– extract all consumer surplus from the lowest-demand group
– leave some consumer surplus for other groups
• the incentive compatibility constraint
– offer less than the socially efficient quantity to all groups other
than the highest-demand group
– offer quantity-discounting
• Second-degree price discrimination converts consumer
surplus into profit less effectively than first-degree
• Some consumer surplus is left “on the table” in order to
induce high-demand groups to buy large quantities

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 Non-linear pricing and welfare

• A necessary condition for second-degree price

discrimination to increase social welfare is that it
increases total output

• “Like” third-degree price discrimination

• But second-degree price discrimination is more likely

to increase output

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 Finally, what about the Law
and price discrimination?
• Is PD lawful?
• In the US last century (Clayton Act, and then Robinson-
Patman Act), to protect small shops against large chains
(newly born supermarkets!), PD was deemed illegal
– Mainly on the grounds of unfairness, not economic reasoning
• There were documented cases of prohibited PD by wholesalers to
supermarkets that generated higher final consumers’ prices!
– This paradigm shifted from the 70s (so called US Antitrust
revolution): if PD increases total welfare then not illegal, an
economist argument
• Distinction of PD’s effects:
– Primary, i.e. anti competitive effects against competitors of the
discriminating firm
– Secondary, i.e. anticompetitive effects because the buyers of the
discriminating sellers are treated differently and this harms
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downstream competition
 Finally, what about the Law
and price discrimination?
• Is PD lawful?
• In EU … complicate but the idea is that form the
Treaty of Rome 1957
– PD forbidden mainly because it contradicts the single
market in EU (one price all over EU for the same product)
• A significant part of EU case-law was concerned with
protecting competitors of a dominant and
discriminating firm.
– i.e. courts ruled against PD by a dominant firm if these
impede rivals from selling to the dominant firm’s
customers.
• These practices are considered exclusionary (my line
of current research) 74
END OF PRICE
DISCRIMINATION
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