PRICE DISCRIMINATION
BY INDICATORS
Overview
• Context: Frequently, firms charge different prices to different
market segments
• Concepts: market segmentation, elasticity rule
• Economic principle: If you charge different prices for the same
product, expect arbitrage
Motivation
p
Profit lost to buyers
who are willing to pay more than p M
A
....
....
....
....
....
....
.
.
....
.......
.......
Profit lost due to consumers
who do not buy even though
there are gains from trade
pM
...
...
...
...
...
...
...
...
...
...
...
...
...
...
...
π
q
M
B
.
....
....
....
...
....
....
.
.
.
...
.......
.......
MR
...
...
...
...
...
...
...
...
...
...
...
...
MC
D
q
Example: laptop pricing
• Production cost is $1,200
• Three types of buyers:
Type
W.T.P. ($)
No. (K)
Cum. No.
1
3000
10
10
2
2000
20
30
3
1000
30
60
Example (cont.)
• Strategy 1: Price at $3000
Profit = ($3000−$1200) × 10K = $18m
• Strategy 2: Price at $2000
Profit = ($2000−$1200) × 30K = $24m
• Strategy 3: Price at $3000 for Type 1
Price at $2000 for Type 2
Profit = ($3000−$1200) × 10K +
+ ($2000−$1200) × 20K = $34m
• Bottom line: If price discrimination is possible, it pays
Customer markets
• In many markets, the number of customers is relatively
small and the seller has considerable information about
buyers
• Examples: ready-mixed concrete, large commercial
aircraft, enterprise software, tug boat push services
• Although there is a list price (rack rate), each customer
receives a discount (often negotiated)
• Final price depends on customer’s ability to pay,
bargaining power
Perfect price discrimination
• Each customer is charged a different price — exactly his/her
willingness to pay (“from each, according to his/her willingness”)
• Examples: plumber, lawyer, piano teacher; customer markets
• With respect to normal pricing,
− The seller gains: revenue and profits go up
− The low-price buyer often gains
− The high-price buyer often loses
• Net effect: not clear whether this is good or bad for society as a
whole. It depends!
Practical difficulties
• Market research: group identification
• Arbitrage: resale, gray markets, harvesting
• Legal limits, US: injury to competition
• Legal limits, EU: single market
• Coming next: All approaches to PD are approximations
to PPD; we will talk about some possible strategies
Types of price discrimination
• Perfect price discrimination
• By indicators: market segment can be directly identified
− Trick: apply elasticity rule to each market segment
• By self-selection: market segment cannot be directly identified
− Trick: offer options such that each consumer will pay what they are
willing to pay
Discrimination by indicators
• Different segments can be identified directly
(i.e., it’s easy to know who’s who)
• Examples?
• Rule: different elasticities ⇒ different prices.
Specifically, higher prices in less elastic markets (elasticity rule):
pi − MC
1
=
pi
−i
where
i ≡
d qi pi
d pi qi
Markups on European cars
Model
Belgium
France Germany
Italy
UK
Fiat Uno
7.6
8.7
9.8
21.7
8.7
Nissan Micra
8.1
23.1
8.9
36.1
12.5
Ford Escort
8.5
9.5
8.9
8.9
11.5
Peugeot 405
9.9
13.4
10.2
9.9
11.6
Mercedes 190
14.3
14.4
17.2
15.6
12.3
• What’s going on here?
Takeaways
• Key issues for price discrimination are:
− Identifying market segments
− Avoiding arbitrage
• With clear, separate segments: apply elasticity rule to each
separately