PriceDiscrimination
ALevelEconomics
Studentsshouldbeableto:
•
•
•
Explainandevaluatethepotentialcostsandbenefitsof
monopolytobothfirmsandconsumers
Explaintheconditionsnecessaryforpricediscriminationto
takeplaceandgiverelevantexamples
Diagramsshouldalsobeusedtosupporttheunderstanding
ofpricediscrimination
WhatisPriceDiscrimination?
• Pricediscriminationisdefinedasabusinesschargingdifferent
consumersdifferentpricesforthesameproduct
• Pricevariationsdonotfullyreflectthemarginalcostof
supplyingaproducte.g.highercostsforparcelsdeliveredover
shortandlong-hauldistancesintheUKandoverseas
• Thereareseveraltypesofpricediscrimination
1. 1st degreediscrimination
2. 2nd degreediscrimination
3. 3rd degreediscrimination
4. TheHurdleModelofpricediscrimination
• Pricediscriminationisnotthesameasproductdifferentiation
wherethequality/characteristicsofthegood/servicevaryby
thetypeofcustomer
TypesofPriceDiscrimination
1st degree
• Chargingdifferentpricesforeachindividual unitpurchased
– i.e.peoplepaytheirownindividualwillingnesstopay
2nd degree
• Pricesvaryingbyquantitysolde.g.bulkpurchasediscounts
• Pricesvaryingbytimeofpurchasee.g.peak-timeprices
3rd degree
• Chargingdifferentpricestogroupsofconsumers
segmentedbypriceelasticityofdemand,income,age,sex
MainAimsofPriceDiscrimination
ExtraRevenue
Providing thatextraunits
ofagood orservicecan
besoldforapriceabove
themarginalcostof
supply, price
discrimination isan
effectivewaytoincrease
revenueandprofits
HigherProfit
UseUpSpare
Capacity
ImprovedCashFlow
Pricediscrimination takes
usawayfromthe
standardassumption in
theory ofthefirm that
thereisasingleprofitmaximisingpriceforthe
samegood orservices
HurdleModelofPriceDiscrimination
• ThehurdlemodelisassociatedwitheconomistProfessorRobertFrank
• Thehurdlemethodseparatesbuyerswithlowwillingnesstopayfrom
thosehappytopayapremiumprice– oftentobethefirsttouseit
• Totakeadvantageofalowerprice,theconsumermustbepreparedto
overcomeorjumpoversomekindofhurdlewhichactsasan
inconvenience.Forexample:
1. Theymighthavetodelayapurchaseuntilaproductisremaindered,
soldoffatlowerpriceswhenamoreadvancedversionisavailable
e.g.secondeditionpaperbacks,olderDVDs
2. Theymayhavetorisknotgettingtheproductatatimeandplaceof
theirchoosinge.g.relyingonstand-byticketsforshowsandairlines
3. Theymaygetadeeperdiscountiftheproductismildlydamagedor
onceused e.g.dentedhouseholdappliances- “seconds”
4. Discountsmayrequirecustomerstocollect&redeemcoupons
• Customerspreparedtodothistendtobemorepricesensitive(Ped>1)
HurdleModelofPriceDiscrimination
Cheaperpricesfor
nearlynewproducts
Discountsforthose
preparedtocollect
coupons
Cheaperpaperbacks
published afterthe
hardbackrelease
Onceusedor
remainderstocksof
computergames
Discountticketbooths
forstand-by/lastminutepurchasers
Discountsonlyfor
customerswhovisitthe
storeonagivenday
ConditionsforPriceDiscrimination
Firmsmusthavesufficientmonopoly(market)power
• Monopolistsalwayshavepricingpower– pricemakersnottakers
Identifyingdifferentmarketsegments
• I.e.consumerswithdifferentpriceelasticitiesofdemand
Abilitytoseparatedifferentgroups
• Requiresinformation/sufficientmarketintelligence
Abilitytopreventre-sale(arbitrage)
• Nosecondarymarketswherearbitragecantakeplaceat
intermediatepricese.g.limitingsales,age-restrictions,IDcards
PriceDiscriminationinAction
Markethaggling
Mobilephone
contracts/tariffs
Taxifaresatpeak
timesoftheday
Cinematicket
prices
Hairdresser
discounts
Educational
bursaries
RecentExamplesofPriceDiscrimination
• Jan2016:ThepopularonlinefashionretailsiteAsos has
decidedtointroducezonalpricing– i.e.chargingvaried,
morecompetitive,pricesindifferentpartsoftheworld
• Dec2015:Nurofen wasfoundguiltybyanAustraliancourtof
misleadingcustomersbysellingthesamepainkillersat
differentprices.
• Dec2015:Moreairlines decidetouseonlineauctionsusing
emailstoexistingcustomerstosellpremiumseatsrather
thangivingthemtoloyalcustomersforfree
• Nov2015:Airbnb introducesasmartpricingmodel- Airbnb
announcedapricingtoolthatwilladjusttochangingsupply
anddemandconditionsinalocalarea
• Oct2015:WHSmithaccusedofpricegouging– i.e.selling
productssuchasbottledwaterforsignificantlyhigherprices
intheirhospitaloutletsthaninnearbyhighstreetstores
Hyper-Targeting:PersonalisedPricing
B&Qtesting
electronicpricetags
Targeteddealsfor
onlinecustomers
Personalisedloyalty
cards/userprofiles
E-CommerceandtheRiseofPersonalisedPricing
Nowmorethaneverbusinesseshavethepotentialtoharnessinformation
containedindigitalprofilesofcustomerstoofferbespoke,personalisedprices
fordifferentgoodsandservices.Thecostsofmarketandconsumer
segmentationarecomingdown.Onsomewebsites,differentdealsandprices
appearasperthelocation,browsinghistoryandoperatingsystemusedbythe
potentialbuyer.Isthisformofhyper-pricetargetinglegaland/orethical?
NurofenandPriceGougingAllegations
NurofenwasfoundguiltyinDecember2015byanAustraliancourtof
misleadingcustomersbysellingthesamepainkillersatdifferentprices.
Labelsonthepacksofitsanalgesicdrugssuggesttheytargettypesof
painsuchasmigraines,periodpainandsorebacks.Infact,theyall
containthesameingredient– ibuprofenlysine
TicketPricesatVueCinema(Leeds)
MenuPricesatJimmyChung’s
JimmyChung’sEdinburgh
Lunch
Monday- Thursday- (12.0016.30)
£6.49perperson
(children under 11years£3.99)
Friday- Sunday - (12.00-16.30)
£6.99perperson
(children under 11years£4.49)
Dinner
Sunday- Thursday- (17.0022.30)
£10.49perperson
(children under 11years£4.99)
Friday- Saturday- (17.00- 23.00)
£11.49perperson
(children under 11years£5.49)
Pricesmayvaryduring
Local/Public/Schoolholidays,
Easter,andDecemberperiod.
EntryChargesforYorkMinster
ProductDifferentiationatWork?
DifferentiationandPriceDiscrimination
2nd DegreePriceDiscriminationatWork
HeavyUsersPayLessforGas&Electricity
Fuel
Electricity
Gas
Size ofconsumer(non-household users)
VerySmall
Small
Small/Medium
Medium
Large
VeryLarge
ExtraLarge
Average
VerySmall
Small
Medium
Large
VeryLarge
Average
PenceperkWh
13.19
12.24
10.96
10.04
9.60
9.48
9.23
10.45
4.949
3.198
2.578
2.024
1.716
2.749
SpottheHalfTermHoliday!
3rd DegreePriceDiscriminationAnalysis
3rd degree pricediscrimination involvessegmenting consumersintogroups
Price
Elasticdemand–
consumersresponsive
tosmallpricechanges
Price
Inelasticdemand–
highwillingness/
abilitytopay
MC
MC
AR
MR
Output
AR
MR
Output
3rd DegreePriceDiscriminationAnalysis
Pricesensitiveconsumers withlowerwillingness topayarechargedless
Price
Elasticdemand–
consumersresponsive
tosmallpricechanges
Price
P1
Inelasticdemand–
highwillingness/
abilitytopay
MC
MC
AR
MR
Q1
Output
AR
MR
Output
3rd DegreePriceDiscriminationAnalysis
WhenPed<1firmscanraisetheirpriceandextractconsumer surplus
Price
Elasticdemand–
consumersresponsive
tosmallpricechanges
Inelasticdemand–
highwillingness/
abilitytopay
Price
P2
P1
MC
MC
AR
MR
Q1
Output
AR
MR
Q2
Output
PeakandOffPeakDemandandPricing
Atoff-peaktimes,marketdemandislowandfirmswillhavesparecapacity
Price
MC
Poff-peak
ARoffpeak
MRoffpeak
Q1
Output
PeakandOffPeakDemandandPricing
Atpeaktimes, marginalcostmayalsobehigher ascapacitylimitsarereached
Price
MC
Ppeak
ARpeak
Poff-peak
MRpeak
ARoffpeak
MRoffpeak
Q1
Q2
Output
SeasonalDemandforHotelsintheUSA
2011
2012
2013
2014
2015
80.0%
Occupancyrate(percent)
75.0%
70.0%
65.0%
60.0%
55.0%
50.0%
45.0%
40.0%
Jan
Feb March April
May
June
July
Aug
Sep
Oct
Nov
Dec
Theoccupancyrateofhotelsfollowsaseasonpatternreachinga
peakduringthesummermonths.Atoff-peaktimes,theoccupancy
ratecandeclinetolessthan50%i.e.thereisplentyofsparecapacity
UberandPriceDiscrimination
• Uberisafast-growingtaxiserviceappthat
nowoperatesinmorethan50countries
• InMay2015,Uberwasvaluedatabout41
billionU.S.dollarsbyventure-capitalfirms
• Uberengagesinsurgepricing– alsoknown
asdynamicpricing
• Whenmarketdemandout-stripsavailable
supplye.g.atpeaktimes,thenUberraises
theaveragefareontheirapp
• Theaimistoencouragemoredriversto
taketotheroadstoexpandsupply
• Thebusinessistakingadvantageoflow
priceelasticityofdemandatbusytimes
• Someeconomistshavecriticisedthispolicy
especiallyduringemergenciessuchasfreak
weathereventsandterroristattacks
SurgePricing
PeakDemand
TheWelfareCaseAgainstPriceTargeting
Exploitationoftheconsumer– themajorityof
consumerstillpaymorethanmarginalcost
Extractionofconsumersurplusturnedinto
higherproducersurplus/supernormalprofit
Possibleuseofdiscriminationasalimitpricing
tactic/andabarriertoentrytorivalfirms
Ultimately,ifsuccessful,itreinforcesthe
monopolypower/dominanceofexistingfirms
ArgumentsinSupportofPriceTargeting
Potentialforcrosssubsidyofactivitiesthatbring
socialbenefitsi.e.chargingmuchlowerpricesfor
drugsinlower&middle-incomecountries
Makingbetteruseofsparecapacity– thiscan
haveenvironmentalbenefits– lesswasteetc
Itbringsnewconsumersintomarket– whowould
otherwiseexcludedbya‘normal’higherprice
Useofmonopolyprofitforresearch– thisisa
stimulustoinnovation/dynamicefficiencygains
PriceDiscrimination
EdExcelA2MicroTopic3.3.9
Studentsshouldbeableto:
•
•
•
Explainandevaluatethepotentialcostsandbenefitsof
monopolytobothfirmsandconsumers
Explaintheconditionsnecessaryforpricediscriminationto
takeplaceandgiverelevantexamples
Diagramsshouldalsobeusedtosupporttheunderstanding
ofpricediscrimination