Price Discrimination

Price Discrimination:

So far we have assumed that a monopoly always sells all output at the same price. That is why if the monopolist wanted to sell more output, it had to lower the price on all the units it was producing.

Sometimes monopolies can charge different customers different prices for the same good, or it can charge the same costumer different prices for different quantities of a good.

Examples:

NS Power. First 400 KW hours at 8.29 cents per kw. Additional units at 7.28 cents.

Plane tickets. If you book a ticket to leave later today, you would pay far more than booking ahead and staying over a Saturday night. This practice discriminated between vacationers and other people with an elastic demand for airfare from business travellers who find out on Tuesday they need to attend a meeting in Vancouver on Wednesday.

Movie Tickets. Cheap Tuesdays, Seniors and children’s discounts versus the ‘where else can I take a date on a Saturday night’ crowd.

Doctors in isolated communities (before Canadian health care): Low price for the poor, and a high price for the rich.

Conditions for price discrimination:

Monopoly power: In a perfectly competitive market, you can’t set the price, so how can you make it higher for some and lower for others? As airlines become more competitive, the amount of price discrimination declines. Canjet doesn’t seem to make much difference in price for early booking.
Identify groups of customers who have different elasticities of demand; How can the airline tell will pay more for an airplane ticket, who will pay less? Staying over on Saturday night is easy on a holiday, a real pain on a business trip. Business travelers are more likely to discover at the last minute that they need to travel. (Going to funerals or a relatives death bed also involves last minute travel. Special bereavement rates which are usually only twice the
Limit their ability to resell the product between groups. If you can book ahead for a cheap ticket and then resell it at the door of the airport to last minute travelers, you could make money – but the travelers name has to be on the ticket. Kids and seniors can’t sell movie tickets to teenagers – not if the ticket taker looks at the ticket and the person handing it in. Some retail outlets give senior discounts on particular days – and some people doubtless have granny or grandpop do their shopping for them – but retail shores are much more reluctant than barbers of movie theatres to discriminate.

Perfect Price discrimination: The firm is able to sell every unit to the consumers who will pay the very highest price for it.

The first unit of this product can be sold at a very high price. Say it’s a plane ticket to Toronto. So if the airline can identify those will pay this price, they will charge the maximum price. Then if they can find out who will be at the next price and soak them for the maximum they will spend the firm can collect much higher total revenues than if it charged one price.

As a result, with perfect price discrimination the firm produces where Price = MC, just as in a competitive industry. It achieves allocative efficiency. But it also converts all the consumer surplus to producer surplus.

Since the firm doesn’t have to lower the price on the first units sold when it sells more, the price and the marginal revenue are the same. If it sells one more unit, it gets the price for that unit without having to reduce the price on other units.

Most discriminating firms have only one or two prices. In some cases, the discounts may really be a reduction below the price they would charge if they couldn’t discriminate. An airline with 3 different prices might look like this. P1 might be paid by the last minute business traveler. P2 by the business traveler who books ahead, but doesn’t stay over a Saturday night. P3 is the price paid by the person who books ahead and stays over the Saturday night. The vacationer gets a better price than if the monopolist didn’t discriminate.

Note: It isn’t price discrimination to charge a different price if the costs of providing the product differ. The cheaper price for a 6 am flight rather than a 11 am flight may not be price discrimination. The six am flight is much more likely to have empty seats than the 11 am flight – many people don’t want to start that early in the day, and people are much less likely to be flying in from other airports to make a connection at 6 am than at 11 am.

In the same way, higher prices at Christmas reflect the higher cost of selling another seat when the planes are full than when the planes are half empty.

Remember the price discriminating country doctor? The justification given was that if she charged the same price to both rich and poor, the total income would be too little to justify setting up practice in the small rural community. If she charged everybody a high price, poor people couldn’t use her services, and she would have too little business to make a living. If he charged everybody a low price, he would be busy, but his total income would still be too small.

So while perfect price discrimination certainly seems unfair since the monopolist turns 100% of consumer surplus into producer surplus, sometimes price discrimination makes some people better off – and very often it will be those who are less able to pay high prices who are offered the lower price.

(Sometimes poorer people have less flexibility than richer people, and then they might be forced to pay more. Super markets may charge higher prices in a poor neighbourhood where people don’t have cars than in a neighbourhoods where they do have cars, because people can’t shop elsewhere.)