# Econ Ch. 13 and 14 - Chapters 13 and 14 Direct and Indirect...

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Chapters 13 and 14: Direct and Indirect Price Discrimination ECON 308: Economics for Managers Professor Svorny
Introduction: Pricing schemes This chapter looks at ways of (profitably) designing and implementing price discrimination schemes Sellers use more than one price They charge consumers prices based on differences in consumer demand Sellers increase their profits (compared to a single, uniform price)
Price Discrimination Charging different prices to different consumers Direct Price Discrimination Firm can separate consumers Indirect Price Discrimination (Chapter 14) Relies on self-identification by consumers
Price Discrimination: Moving resources to higher valued uses Price (value to consumers) Q Total Revenue Marginal Revenue Marginal Cost 7 1 7 7 1.50 6 2 12 5 1.50 5 3 15 3 1.50 4 4 16 1 1.50 3 5 15 -1 1.50 2 6 12 -3 1.50 1 7 7 -5 1.50 The profit- maximizing firm would produce three units. However, the fourth unit costs less to make than what it is worth to consumers. Hmmm…
You can see that at the profit maximizing quantity and price , the demand curve (past Q*) shows consumers value an incremental unit more than it would cost to produce (MC). If you could sell the next units (Q‘ – Q*) at the prices on the demand curve you could increase your profits. See the two-sided purple arrows below: \$5 Q* MR D MC MR = MC
Pricing tradeoff & discrimination Frequently there is a pricing tradeoff based on simple demand curves: Lower price sell more, but earn less on each unit sold Higher price sell less, but earn more on each unit sold Marginal analysis tells us how to optimize around this tradeoff: MR=MC  (P-MC)/P=1/|e| Price discrimination allows sellers to avoid the tradeoff Higher prices for some Lower prices for others
Price discrimination Motivation : price discrimination allows a firm to sell items to low-value customers who otherwise would not purchase because the price is too high It allows the firm to capture consumer surplus It allows a wealth-creating transaction (moving resources from lower- to higher-valued uses)
Price discrimination Definition : Price discrimination is the practice of charging different prices that are not cost-justified to different people • P 1 /MC 1 P 2 /MC 2 . Price discrimination allows two optimal prices to be set for two groups with different levels of price elasticity: • (P 1 -MC 1 )/P 1 =1/|elasticity 1 | • (P 2 -MC 2 )/P 2 =1/|elasticity 2 |
Price discrimination The bigger the difference between group elasticities, the more profit there is in designing a price discrimination scheme. To price discriminate ID different groups with different price elasticities or different values Find a way to prevent arbitrage
Price discrimination