Overview
This lecture explains price discrimination, where firms charge different prices for identical goods without cost differences, discussing its types, necessary conditions, and impacts.
Definition and Conditions for Price Discrimination
- Price discrimination is when a firm charges different consumers different prices for the same good without cost differences.
- Three conditions for price discrimination: (1) price-making (monopoly) power, (2) ability to segment markets based on price elasticity of demand (PED), and (3) ability to prevent resale (market seepage).
- Firms collect consumer data to identify and segment customers based on their PED.
Degrees of Price Discrimination
- First-degree price discrimination: Each consumer is charged their maximum willingness to pay, eliminating all consumer surplus and converting it into monopoly profit.
- Second-degree price discrimination: Prices vary by quantity or time, such as last-minute deals to fill excess capacity; consumers buying at lower prices gain extra consumer surplus.
- Third-degree price discrimination: Market is segmented into groups with different PED (e.g., peak vs. off-peak train travelers); higher prices charged to inelastic groups, lower prices to elastic groups, maximizing joint profits.
Diagrams and Examples
- First-degree: Consumer surplus triangle is entirely converted to monopoly profit.
- Second-degree: Diagram shows profit-maximizing output with excess capacity filled at lower prices, benefiting last-minute buyers.
- Third-degree: Two markets with different AR and MR curves, showing higher prices in inelastic and lower prices in elastic markets.
Pros and Cons of Price Discrimination
- Cons: Leads to allocative inefficiency, consumer exploitation (especially inelastic markets), increased income inequality, and potential anti-competitive behavior.
- Pros: Can result in higher profits for firms, potential for greater dynamic efficiency and economies of scale, occasional consumer benefits (e.g., last-minute deals), and the ability to cross-subsidize other products.
Key Terms & Definitions
- Price Discrimination — Charging different prices to different consumers for the same product with no cost difference.
- Price Elasticity of Demand (PED) — Measure of how much quantity demanded responds to a price change.
- Consumer Surplus — Difference between what consumers are willing to pay and what they actually pay.
- Monopoly Power — The ability of a firm to set prices due to lack of competition.
Action Items / Next Steps
- Learn the definitions and distinctions between the three degrees of price discrimination.
- Practice drawing and labeling diagrams for each type.
- Review examples of real-world price discrimination.