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Unformatted text preview: 465 Chapter 20 _________________________ PRICE DISCRIMINATION R. Preston McAfee * This chapter sets out the rationale for price discrimination and discusses the two major forms of price discrimination. It then considers the welfare effects and antitrust implications of price discrimination. 1. Introduction The Web site of computer manufacturer Dell asks prospective buyers to declare whether theyare ahome user, small business, largebusiness or governmententity. Two years ago, thepriceof a512MBmemory module, part number A0193405,dependedon which business segment one declared. At that time, Dell quoted $289.99 for a large business, $266.21 for a government agency, $275.49 for a home, and $246.49 for a small business. What explains these price differences? How does Dell benefit from it? Different segments have different willingness to pay. Dell optimizes its prices, offering lower prices to relatively price-sensitive segments. An interesting aspect of Dells attempt to charge different prices to different customers is that the customers aid Dell in its effort. According to a Dell spokesperson, each segment independently sets prices and the customer is free to buy from whichever is cheapest. Thus, the customers paying more are choosing to pay more, probably because they do not expect the prices to vary so significantly. This chapter explores the economic rationale for price discrimination. Section 2 presents the basic theoryof price discrimination and describes the conditions necessary for price discrimination to exist. Section 3 then discusses direct price discrimination, while indirect price discrimination is discussed in Section 4. Section 5 provides a discussion of the welfare effects associated with price discrimination, while Section 6 concludes this chapter with a discussion of the antitrust implications of price discrimination. 2. Basic theory of price discrimination Price discrimination can exist when three conditions are met: consumers differ in their demands for a given good or service, a firm has market power, 1 and the firm can prevent or limit arbitrage. If consumers had identical demands for a good, then all consumers woulddemand thesameamount of thegoodfor eachprice, andthepriceand * California Institute of Technology . 1. Market power as used in this chapter refers to the economic definition of the term, which is the abilitytopriceabovemarginal cost. See STEVENE.LANDSBURG,PRICETHEORYANDAPPLICATIONS 329 (6thed. 2005); FranklinM. Fisher, Detecting Market Power , whichappears as Chapter 14 inthis book. R. Preston McAfee, Price Discrimination , in 1 ISSUES IN COMPETITION LAW AND POLICY 465 (ABA Section of Antitrust Law 2008) 466 ISSUES IN COMPETITION LAW AND POLICY quantity of the good would depend only on the number of consumers in the market and the ability of firms to supply the good (the supply curve). If firms have no market power, that is, no ability to affect the price of the goods they sell, the theory of perfect competition implies that all goods would be sold at one price (the law of one price).competition implies that all goods would be sold at one price (the law of one price)....
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