Price discrimination

Price discrimination
• The practice of setting different prices for the same good, whereby
the relevant price in each case depends on
• the quantity purchased,
• the buyer’s characteristics,
• various sale clauses
Assumptions
• No resale (no arbitrage)
• The good is the same
Types of price discrimination
• First-degree price discrimination:
• Personalized pricing
• perfect discrimination (unique price for each consumer)
• Second-degree price discrimination:
• Menu pricing
• self-selection
• a unit price depends on quantity purchased
• Third-degree price discrimination:
• Group pricing
• selection by indicators (characteristics that signal about the willingness to pay)
First degree price discrimination.
Nonlinear pricing
First degree price discrimination
• Financial aid to undergraduate students on the basis of some measure
of need
• How is this an example of first degree price discrimination?
Two-part pricing
• A fixed fee (membership fee): entitles the consumer to buy the good
or service, but is independent of the quantity purchased
• A price or usage fee charged per unit bought
Second-degree price discrimination
• Versioning, bundling, different “deals” (combinations of price and
quantity), so that consumers self-select according to the group they
belong to
• Versioning
• Business and first class in airplane, “gold” and “platinum” cards, paperback
and hardcopy books, etc.
• Sometimes, firms might reduce the quality of some of the existing products in
order to price-discriminate – produce damaged goods
Second-degree price discrimination
• Bundling
• Selling equipment + maintenance service
• Computer + Office package

• Pure bundling: purchase the bundle or nothing

• Mixed bundling: a bundle or one of the separate parts
Third-degree price discrimination
• The most common form of price discrimination
• Group pricing
• Linear pricing (AP = MP)
• The seller can divide buyers intro groups, setting a different price of
each group – market segmentation
• Examples: geographical location, age, annual income, gender, etc.

• Monopolist can prevent arbitrage across the different groups

Case: Price discrimination in the European
car market
Two-market model

As the MR is equal to MC when profit is maximized,

Under third-degree price discrimination, a seller should charge a lower price

in those market segments with greater price elasticity
Third-degree price discrimination:
implementation
• Book in the United States is PU = 36 − 4QU and in Europe is PE = 24 −
4QE
• MC = $4 in both markets
• Nondiscriminatory price: treat two markets as single
• Add two market curves horizontally
Is price discrimination legal? Should it be?
• Total welfare is greater under price discrimination
• Consumer welfare is lower under price discrimination
• Different consumers pay different prices under price discrimination
• More consumers are served under price discrimination

• So, there is the trade-off between efficiency and consumer welfare

• Welfare distribution concerns
Price discrimination: public policy
• In the U.S. and the EU there are very strict laws about price
discrimination BUT
• The EU is very concerned with price discrimination within Europe but less so
between Europe and the rest of the world
• Price discrimination between the US and the rest of the world is difficult:
parallel imports are allowed
• First-time subscribers to the Economist pay a lower rate than repeat
subscribers. Is this price discrimination? Of what type?

• A restaurant in London has removed prices from its menu: Each

consumer is asked to pay what he or she thinks the meal was worth.
Is this a case of price discrimination?
• A market consists of two population segments, A and B. An individual
in segment A has demand for your product q = 50 − p. An individual in
segment B has demand for your product q = 120 − 2p. Segment A has
1000 people in it. Segment B has 1200 people in it. Total cost of
producing q units is C = 5000 + 20q.
• a. What is total market demand for your product?
• b. Assume that you must charge the same price to both segments.
What is the profit maximizing price? What are your profits?
• c. Imagine now that members of segment A all wear a scarlet “A” on
their shirts or blouses and that you can legally charge different prices
to these people. What price do you change to the scarlet “A” people?
What price do you charge to those without the scarlet “A”? What are
your profits now?
• 10.8 and 10.9 in Cabral’s book (p.186)

• Try to do 10.17 (p.188)