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Industrial Organization I

Industrial Organization I. Price discrimination. Classification. Methods. Linear pricing: Same price for all units purchased, but price differs by consumer type (“personalized” pricing) Non-Linear pricing: Take it or leave it package offer x units of a good at package price “r”

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Industrial Organization I

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  1. Industrial Organization I Price discrimination

  2. Classification

  3. Methods • Linear pricing: • Same price for all units purchased, but price differs by consumer type (“personalized” pricing) • Non-Linear pricing: • Take it or leave it package offer • x units of a good at package price “r” • Two-part tariff: • Fixed fee “A” • Per unit price “p” Can be “personalized” or not

  4. Complete Discrimination (1st) • All consumer surplus is extracted • Firm requires detailed information about willingness to pay • Examples: high prices with bargaining • Used cars salesmen • College admission (financial aid)

  5. Complete Discrimination • Example: 2 potential used car buyers (unit demand) $ $ Buyer 1 Buyer 2 10,000 Uniform Price= $9,000 Profit = $ 9,000 8,000 Consumer Surplus Q Q 1 1

  6. Complete Discrimination (case 1) • Unit demand Buyer 2 Buyer 1 $ $ Price 1 = $10,000 10,000 Price 2 = $8,000 8,000 Q Q 1 1 • Complete Discrimination: Profit =10,000 (buyer 1) + 8,000 (buyer 2) = 18,000 • Consumer surplus = 0

  7. Complete Discrimination (case 2) • Case 2: Multiple-unit demand $ 800 Uniform Price 500 Q 5

  8. Complete Discrimination (case 2) Multiple-unit demand • How to achieve perfect price discrimination? • Non-linear pricing: • Option 1: take it or leave it price-quantity package • Option 2: two-part tariff

  9. Complete discrimination (case 2) • Multi-unit demand: a simple model • Utility is quasi-linear: • This simplifies to: Inverse demand

  10. Multi-unit demand: a simple model • Example. Suppose: • Also, • What is the profit maximizing quantity? • What is the profit maximizing (package) price? (option 1) • What is the optimal two-part tariff? (option 2) Inverse demand

  11. Direct Discrimination • Different groups of consumers pay different prices: • More price sensitive consumers pay a lower price • Less price sensitive consumers pay a higher price • Firm requires information about groups and can identify them easily/legally. • Examples: Haircuts, students, 65+, coach/business, dry cleaning, “Ladies Night”

  12. Direct Discrimination p1 p2 • Maximization rule: MR1 = MR2 = MC • Intuition: If MR1>MR2, q1 can increase & q2 decrease until MR1=MR2 • More sensitive segment (elastic) pays a lower price (group 1) • Less sensitive segment (inelastic) pays a higher price (group 2) • Π is higher than with uniform pricing p*2 D2 p*1 D1 MC=8 q*1 q1 q*2 q2 MR1 MR2

  13. Direct Discrimination • Mathematically: • Monopolist solves: • Example: P1=200-4Q ; P2=152-6Q ; MC=8 • What is P1*, Q1*, P2*, Q2*

  14. Direct Discrimination • Formally: • Monopolist solves: • Foc’s are: • After some manipulation:

  15. Direct Discrimination: Welfare p p1 p2 • In some cases, price discrimination provides goods and services to groups that would not have access under uniform pricing: • Prescription drugs: developed vs. developing countries D1 + D2 MC p*2 D2 p*1 D1 q*1 q1 q*2 q2 Q* MR Q MR1 MR2

  16. Direct Discrimination: Welfare • Firm is better off (in the worst case the firm is as well off) • Consumers in low elasticity markets are worse off • Consumers in high elasticity markets are better off

  17. Direct Discrimination: Inter-related Demands • Direct (or group) price discrimination analysis also applies to “inter-related” demands: • Electricity (off peak v. peak) • Durable goods markets • Monday night movie discounts? Wing Tuesday?

  18. Indirect Discrimination • Consumers self-select • Firm knows about two (or more) consumer types • It is unfeasible (or illegal) to use direct discrimination • Again, two possible kinds of “packages” • Two-part tariff: e.g. $100 for a plan, and 10c/min after 1000 min • Take it or leave it offer: buy one get one 50% off.

  19. Indirect Discrimination • Packages must comply with 2 constraints: • Incentive compatibility: we want groups to select the package designed for them • Participation: avoid packages that are less attractive than not buying at all

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