PriceDiscrimination

ALevelEconomics

Studentsshouldbeableto:• Explainandevaluatethepotentialcostsandbenefitsof

monopolytobothfirmsandconsumers• Explaintheconditionsnecessaryforpricediscriminationto

takeplaceandgiverelevantexamples• Diagramsshouldalsobeusedtosupporttheunderstanding

ofpricediscrimination

• Pricediscrimination isdefinedasabusinesschargingdifferentconsumersdifferentpricesforthesameproduct

• Pricevariationsdonotfullyreflectthemarginalcostofsupplyingaproducte.g.highercostsforparcelsdeliveredovershortandlong-hauldistancesintheUKandoverseas

• Thereareseveraltypesofpricediscrimination1. 1st degreediscrimination2. 2nd degreediscrimination3. 3rd degreediscrimination4. TheHurdleModelofpricediscrimination

• Pricediscrimination isnotthesameasproductdifferentiationwherethequality/characteristicsofthegood/servicevarybythetypeofcustomer

WhatisPriceDiscrimination?

• Chargingdifferentpricesforeachindividualunitpurchased– i.e.peoplepaytheirownindividualwillingnesstopay

1st degree

• Pricesvaryingbyquantitysolde.g.bulkpurchasediscounts• Pricesvaryingbytimeofpurchasee.g.peak-timeprices

2nd degree

• Chargingdifferentpricestogroupsofconsumerssegmentedbypriceelasticityofdemand,income,age,sex

3rd degree

TypesofPriceDiscrimination

MainAimsofPriceDiscrimination

ExtraRevenue HigherProfit ImprovedCashFlow

UseUpSpareCapacity

Providing thatextraunitsofagoodorservicecanbesoldforapriceabovethemarginalcostofsupply,pricediscrimination isaneffectivewaytoincreaserevenueandprofits

Pricediscrimination takesusawayfromthestandardassumption intheoryofthefirmthatthereisasingleprofit-maximisingpriceforthesamegoodorservices

HurdleModelofPriceDiscrimination• ThehurdlemodelisassociatedwitheconomistProfessorRobertFrank• Thehurdlemethodseparatesbuyerswithlowwillingnesstopayfrom

thosehappytopayapremiumprice– oftentobethefirsttouseit• Totakeadvantageofalowerprice,theconsumermustbepreparedto

overcomeorjumpoversomekindofhurdlewhichactsasaninconvenience.Forexample:1. Theymighthavetodelayapurchaseuntilaproductisremaindered,

soldoffatlowerpriceswhenamoreadvancedversionisavailablee.g.secondeditionpaperbacks,olderDVDs

2. Theymayhavetorisknotgettingtheproductatatimeandplaceoftheirchoosinge.g.relyingonstand-byticketsforshowsandairlines

3. Theymaygetadeeperdiscountiftheproductismildlydamagedoronceused e.g.dentedhouseholdappliances- “seconds”

4. Discountsmayrequirecustomerstocollect&redeemcoupons• Customerspreparedtodothistendtobemorepricesensitive(Ped>1)

HurdleModelofPriceDiscrimination

Cheaperpricesfornearlynewproducts

Discountsforthosepreparedtocollect

coupons

Cheaperpaperbackspublished afterthehardbackrelease

Onceusedorremainderstocksofcomputergames

Discountticketboothsforstand-by/last-minutepurchasers

Discountsonlyforcustomerswhovisitthestoreonagivenday

• Monopolistsalwayshavepricingpower– pricemakersnottakers

Firmsmusthavesufficientmonopoly(market)power

• I.e.consumerswithdifferentpriceelasticitiesofdemand

Identifyingdifferentmarketsegments

• Requiresinformation/sufficientmarketintelligence

Abilitytoseparatedifferentgroups

• Nosecondarymarketswherearbitragecantakeplaceatintermediatepricese.g.limitingsales,age-restrictions,IDcards

Abilitytopreventre-sale(arbitrage)

ConditionsforPriceDiscrimination

Markethaggling Mobilephonecontracts/tariffs

Taxifaresatpeaktimesoftheday

Cinematicketprices

Hairdresserdiscounts

Educationalbursaries

PriceDiscriminationinAction

RecentExamplesofPriceDiscrimination• Jan2016:ThepopularonlinefashionretailsiteAsos has

decidedtointroducezonalpricing– i.e.chargingvaried,morecompetitive,pricesindifferentpartsoftheworld

• Dec2015:Nurofen wasfoundguiltybyanAustraliancourtofmisleadingcustomersbysellingthesamepainkillersatdifferentprices.

• Dec2015:Moreairlines decidetouseonlineauctionsusingemailstoexistingcustomerstosellpremiumseatsratherthangivingthemtoloyalcustomersforfree

• Nov2015:Airbnb introducesasmartpricingmodel- Airbnbannouncedapricingtoolthatwilladjusttochangingsupplyanddemandconditionsinalocalarea

• Oct2015:WHSmithaccusedofpricegouging– i.e.sellingproductssuchasbottledwaterforsignificantlyhigherpricesintheirhospitaloutletsthaninnearbyhighstreetstores

Hyper-Targeting:PersonalisedPricing

B&Qtestingelectronicpricetags

Targeteddealsforonlinecustomers

Personalisedloyaltycards/userprofiles

E-CommerceandtheRiseofPersonalisedPricingNowmorethaneverbusinesseshavethepotentialtoharnessinformationcontainedindigitalprofilesofcustomerstoofferbespoke,personalisedpricesfordifferentgoodsandservices.Thecostsofmarketandconsumersegmentationarecomingdown.Onsomewebsites,differentdealsandpricesappearasperthelocation,browsinghistoryandoperatingsystemusedbythepotentialbuyer.Isthisformofhyper-pricetargetinglegaland/orethical?

NurofenandPriceGougingAllegations

NurofenwasfoundguiltyinDecember2015byanAustraliancourtofmisleadingcustomersbysellingthesamepainkillersatdifferentprices.Labelsonthepacksofitsanalgesicdrugssuggesttheytargettypesofpainsuchasmigraines,periodpainandsorebacks.Infact,theyallcontainthesameingredient– ibuprofenlysine

TicketPricesatVueCinema(Leeds)

MenuPricesatJimmyChung’sJimmyChung’sEdinburghLunchMonday- Thursday- (12.00-16.30)£6.49perperson(childrenunder11years£3.99)Friday- Sunday - (12.00-16.30)£6.99perperson(childrenunder11years£4.49)DinnerSunday- Thursday- (17.00-22.30)£10.49perperson(childrenunder11years£4.99)Friday- Saturday- (17.00- 23.00)£11.49perperson(childrenunder11years£5.49)PricesmayvaryduringLocal/Public/Schoolholidays,Easter,andDecemberperiod.

EntryChargesforYorkMinster

ProductDifferentiationatWork?

DifferentiationandPriceDiscrimination

2nd DegreePriceDiscriminationatWork

HeavyUsersPayLessforGas&Electricity

Fuel Size ofconsumer(non-householdusers) PenceperkWhElectricity VerySmall 13.19

Small 12.24Small/Medium 10.96Medium 10.04Large 9.60VeryLarge 9.48ExtraLarge 9.23Average 10.45

Gas VerySmall 4.949Small 3.198Medium 2.578Large 2.024VeryLarge 1.716Average 2.749

SpottheHalfTermHoliday!

3rd DegreePriceDiscriminationAnalysis

Price

Output

Price

Output

ARAR

MRMR

MC MC

Elasticdemand–consumersresponsivetosmallpricechanges

Inelasticdemand–highwillingness/abilitytopay

3rd degreepricediscrimination involvessegmentingconsumersintogroups

3rd DegreePriceDiscriminationAnalysis

Price

Output

Price

Output

ARAR

MRMR

MC MC

Elasticdemand–consumersresponsivetosmallpricechanges

Inelasticdemand–highwillingness/abilitytopay

P1

Q1

Pricesensitiveconsumerswithlowerwillingness topayarechargedless

3rd DegreePriceDiscriminationAnalysis

Price

Output

Price

Output

ARAR

MRMR

MC MC

Elasticdemand–consumersresponsivetosmallpricechanges

Inelasticdemand–highwillingness/abilitytopay

P1

Q1

P2

Q2

WhenPed<1firmscanraisetheirpriceandextractconsumersurplus

Price

Output

PeakandOffPeakDemandandPricing

MRoffpeak

ARoffpeak

MC

Poff-peak

Q1

Atoff-peaktimes,marketdemandislowandfirmswillhavesparecapacity

Price

Output

PeakandOffPeakDemandandPricing

MRoffpeak

ARoffpeak

MC

Poff-peak

Q1 Q2

Ppeak

Atpeaktimes,marginalcostmayalsobehigherascapacitylimitsarereached

MRpeak

ARpeak

SeasonalDemandforHotelsintheUSA

Theoccupancyrateofhotelsfollowsaseasonpatternreachingapeakduringthesummermonths.Atoff-peaktimes,theoccupancyratecandeclinetolessthan50%i.e.thereisplentyofsparecapacity

40.0%

45.0%

50.0%

55.0%

60.0%

65.0%

70.0%

75.0%

80.0%

Jan Feb March April May June July Aug Sep Oct Nov Dec

Occupancyra

te(perce

nt)

2011 2012 2013 2014 2015

UberandPriceDiscrimination

SurgePricing

PeakDemand

• Uberisafast-growingtaxiserviceappthatnowoperatesinmorethan50countries

• InMay2015,Uberwasvaluedatabout41billionU.S.dollarsbyventure-capitalfirms

• Uberengagesinsurgepricing– alsoknownasdynamicpricing

• Whenmarketdemandout-stripsavailablesupplye.g.atpeaktimes,thenUberraisestheaveragefareontheirapp

• Theaimistoencouragemoredriverstotaketotheroadstoexpandsupply

• Thebusinessistakingadvantageoflowpriceelasticityofdemandatbusytimes

• Someeconomistshavecriticisedthispolicyespeciallyduringemergenciessuchasfreakweathereventsandterroristattacks

TheWelfareCaseAgainstPriceTargeting

Exploitationoftheconsumer– themajorityofconsumerstillpaymorethanmarginalcost

Extractionofconsumersurplusturnedintohigherproducersurplus/supernormalprofit

Possibleuseofdiscriminationasalimitpricingtactic/andabarriertoentrytorivalfirms

Ultimately,ifsuccessful,itreinforcesthemonopolypower/dominanceofexistingfirms

ArgumentsinSupportofPriceTargetingPotentialforcrosssubsidyofactivitiesthatbringsocialbenefitsi.e.chargingmuchlowerpricesfordrugsinlower&middle-incomecountries

Makingbetteruseofsparecapacity– thiscanhaveenvironmentalbenefits– lesswasteetc

Itbringsnewconsumersintomarket– whowouldotherwiseexcludedbya‘normal’higherprice

Useofmonopolyprofitforresearch– thisisastimulustoinnovation/dynamicefficiencygains

PriceDiscrimination

EdExcelA2MicroTopic3.3.9

Studentsshouldbeableto:• Explainandevaluatethepotentialcostsandbenefitsof

monopolytobothfirmsandconsumers• Explaintheconditionsnecessaryforpricediscriminationto

takeplaceandgiverelevantexamples• Diagramsshouldalsobeusedtosupporttheunderstanding

ofpricediscrimination