12.c. Market Segmentation

Price discrimination is charging different prices for the same good. Examples of price discrimination are coupons, quantity discounts and movie tickets. For example, consumers who use coupons pay a lesser price for the same good compare to those who do not use the coupons.

There are two conditions that must be met for price discrimination to be successful. First, the firm or industry must have monopoly power, and secondly the resale of the goods must be prevented. If the firm does not have monopoly power, and it price discriminates then the consumers will cease to buy the product from the firm and buy it elsewhere, where they are not price discriminated against. The purpose of price discrimination is that sellers discriminate to capture all of consumer surplus.

An example of imperfect price discrimination is the market for Toyotas. The producer of Toyotas has to determine how many Toyotas to produce and how many they should distribute to the world market and at what price. In this example, lets assume that there are only two markets: the U.S. market and the Japan market.

There are lots of competitions in the U.S. market, not only from other manufacturers of Japanese cars, but also American and European cars. Therefore the demand for Toyotas is more elastic(flatter) than the demand for Toyotas in Japan.

Figure 12d.1 Figure 12d.2

Shows the more elastic demand for Toyotas in the U.S. Shows the less elastic demand for Toyotas in Japan. Where the dash line meets

Where the dash line meets MRA is where MC=MR in Figure 12d.3 MRJ is where MC=MR in Figure 12d.3 and dragged back to Figure 12d.2, to the and dragged back to Figure 12d.1, to the price of $10. Where the price of $10. Where the dashed line meets MRJ is QJ, and so we go up to DJ to dashed line meets MRA, is QA, and so we go up to DA to find the find the price in which Toyotas are sold in Japan, which is PJ. Notice that price in which Toyotas are sold in the U.S., which is PA. PJ>PA. So Toyotas should set prices higher in Japan then the U.S.

Figure 12d.3

This is the total market for Toyotas. ΣMR is the horizontal summation of the MRs from U.S., as well as Japan. Where MC hits ΣMR is how much Toyotas should produce to maximize its profit. It should produce at quantity QT. Now we draw dashed lines from the horizontal to QT and 10. Then we drag the lines to Figure 12d.2 and 12d.1, to find their profit-maximizing quantities and prices.

When price-discriminating, sellers must make sure that the MRs in both market are equal. If MRA>MRJ , then it is more profitable to sell in the U.S., then to Japan, therefore QA will increase and QJ will decrease and if MRA<MRJ , then it is more profitable to sell to Japan then to the U.S.therefore QJ will increase and QA will decrease. Therefore, the profit-maximizing outcome is to set MRA=MRJ. and both MRA and MRJ has to equal to MC in order to maximize (you maximize when MR=MC). So the profit-maximizing equation is MRA=MRJ=MC.

Once ΣMR=MC in the total market for Toyota, we drag the intersection back to the market for each country. Where the dragged line hits the respective MRs then that is the profit-maximizing quantity and profit-maximizing price. Notice that the price of Toyotas in the U.S. is lower than the price of Toyotas in Japan. This is because Toyotas faces a lot of competition in the U.S. market, therefore making its demand curve more elastic than its demand curve in Japan. From the graphs, we can see that price is lower in more elastic market.

Below is a numerical example of an imperfect price discrimination:

Given:

Japan’s Demand Curve: P=40-Q

U.S.’s Demand Curve : P=40-2Q

MC= Q/3

Figure 12d.4 Once the intersection of MC=MR is set Figure 12d.5 Drag back the intersection of MC=MR and find Q and P.

in figure 12d.6 then drag back the intersection to to this figure

and where the intersection hits MR is where Q is and directly

above that on the demand curve is the price that should be set.

Figure 12d.6 Horizontally sum the MRs curve from Japan and U.S.’s markets. Where this hits MC determines how many Toyotas should be produce in total.

Steps to solving:

1. Find MR for each respective market

Japan: P=40-Q U.S.: P=40-2Q

MR= 40-2Q MR=40-4Q

2.  Find ΣMR: horizontally sum, since Q is on the x-axis then sum the Qs

2Q=40-MR 4Q=40-MR

Q=20-.5MR Q=10-.25MR

QJapan+QU.S.= ΣMR

Q=20-.5MR+10-.25MR

Q=30-.75MR

.75MR=30-Q

ΣMR=40-(4/3)Q

3.  Set ΣMR=MC. Find Q and P

40-(4/3)Q=Q/3 MC=Q/3

Q=24 MC=24/3

MC=8

This is the Q in total, in the world market, and 8 is the price at which MC=ΣMR.

4.  Find the prices and quantities of the respective markets

MC=MRJapan MC=MRU.S.

8=40-4Q 8=40-2Q

Q=8 Q=16

P=40-2Q P=40-Q

P=40-8*2 P=40-16

P=24 P=24

Price is the same in both markets because both demand curves have the same elasticity.