PriceDiscrimination

• Pricediscriminationisdefinedasabusinesschargingdifferentconsumers’differentpricesforthesameproduct

• Pricevariationsdonotfullyreflectthemarginalcostofsupplyingaproducte.g.highercostsforparcelsdeliveredovershortandlong-hauldistancesintheUKandoverseas

Thereareseveraltypesofpricediscrimination

• 1stdegreediscrimination• 2nddegreediscrimination• 3rddegreediscrimination• TheHurdleModelofpricediscrimination

Pricediscriminationisnotthesameasproductdifferentiationwherethequality/characteristicsofthegood/servicevarybythetypeofcustomerNecessaryconditionsforpricediscrimination

1. Firmsmusthavesufficientmonopoly(market)powera. Monopolistsalwayshavepricingpower–i.e.pricemakersnottakers

2. Identifyingdifferentmarketsegmentsa. I.e.groupsofconsumerswithdifferentpriceelasticitiesofdemand

3. Abilitytoseparatedifferentgroupsa. Requiresinformation/sufficientmarketintelligenceonpurchasingbehaviourof

consumers4. Abilitytopreventre-sale(arbitrage)

a. Nosecondarymarketswherearbitragecantakeplaceatintermediatepricese.g.limitingsales,age-restrictions,IDcards

MainAimsofPriceDiscrimination

• Providingthatextraunitsofagoodorservicecanbesoldforapriceabovethemarginal

costofsupply,pricediscriminationisaneffectivewaytoincreaserevenueandprofits• Pricediscriminationtakesusawayfromthestandardassumptionintheoryofthefirmthat

thereisasingleprofit-maximisingpriceforthesamegoodorservices

ExtraRevenue HigherProfit ImprovedCashFlow UseUpSpareCapacity

TypesofPriceDiscrimination/DynamicPricing

• 1stdegreeo Chargingdifferentpricesforeachindividualunitpurchased–i.e.peoplepaytheir

ownindividualwillingnesstopay• 2nddegree

o Pricesvaryingbyquantitysolde.g.bulkpurchasediscountso Pricesvaryingbytimeofpurchasee.g.peak-timeprices

• 3rddegreeo Chargingdifferentpricestogroupsofconsumerssegmentedbypriceelasticityof

demand,income,age,sex

Somerecentexamplesofpricediscriminationinthenews:

• Jan2016:ThepopularonlinefashionretailsiteAsoshasdecidedtointroducezonalpricing–i.e.chargingvaried,morecompetitive,pricesindifferentpartsoftheworld

• Dec2015:NurofenwasfoundguiltybyanAustraliancourtofmisleadingcustomersbysellingthesamepainkillersatdifferentprices.

• Dec2015:Moreairlinesdecidetouseonlineauctionsusingemailstoexistingcustomerstosellpremiumseatsratherthangivingthemtoloyalcustomersforfree

• Nov2015:Airbnbintroducesasmartpricingmodel-Airbnbannouncedapricingtoolthatwilladjusttochangingsupplyanddemandconditionsinalocalarea

• Oct2015:WHSmithaccusedofpricegouging–i.e.sellingproductssuchasbottledwaterforsignificantlyhigherpricesintheirhospitaloutletsthaninnearbyhighstreetstores

E-CommerceandtheRiseofPersonalisedPricingNowmorethaneverbusinesseshavethepotentialtoharnessinformationcontainedindigitalprofilesofcustomerstoofferbespoke,personalisedpricesfordifferentgoodsandservices.Thecostsofmarketandconsumersegmentationarecomingdown.Onsomewebsites,differentdealsandpricesappearasperthelocation,browsinghistoryandoperatingsystemusedbythepotentialbuyer.Isthisformofhyper-pricetargetinglegaland/orethical?HurdleModelofPriceDiscrimination

• ThehurdlemodelisassociatedwiththeUSeconomistProfessorRobertFrank• Thehurdlemethodseparatesbuyerswithlowwillingnesstopayfromthosehappytopaya

premiumprice–oftentobethefirsttouseit

Markethaggling Mobilephonecontracts/tariffs

Taxifaresatpeaktimesoftheday

Cinematicketprices

Hairdresserdiscounts

Educationalbursaries

• Totakeadvantageofalowerprice,theconsumermustbepreparedtoovercomeorjumpoversomekindofhurdlewhichactsasaninconvenience.Forexample:

1. Theymighthavetodelayapurchaseuntilaproductisremaindered,soldoffatlowerpriceswhenamoreadvancedversionisavailablee.g.secondeditionpaperbacks,olderDVDs

2. Theymayhavetorisknotgettingtheproductatatimeandplaceoftheirchoosinge.g.relyingonstand-byticketsforshowsandairlines

3. Theymaygetadeeperdiscountiftheproductismildlydamagedoronceusede.g.dentedhouseholdappliances-“seconds”

4. Discountsmayrequirecustomerstocollect&redeemcoupons• Customerspreparedtodothistendtobemorepricesensitive(Ped>1)

Examplesofthehurdlemodelofpricediscrimination

3rdDegreePriceDiscriminationAnalysis

• 3rddegreepricediscriminationinvolvessegmentingconsumersintogroups• Pricesensitiveconsumerswithlowerwillingnesstopayarechargedless• WhenPed<1firmscanraisetheirpriceandextractconsumersurplus

Cheaperpricesfornearlynewproducts

Discountsforthosepreparedtocollectcoupons

Cheaperpaperbackspublishedafterthehardbackrelease

Onceusedorremainderstocksofcomputergames

Discountticketboothsforstand-by/last-minute

purchasers

Discountsonlyforcustomerswhovisitthestoreonagiven

day

PeakandOffPeakDemandandPricing

• Atoff-peaktimes,marketdemandislowandfirmswillhavesparecapacity• Atpeaktimes,marginalcostmayalsobehigherascapacitylimitsarereached• Higherpriceschargedatpeaktimes–akeywayofincreasingrevenueandprofitsat

differentseasonsoftheyear

Price

Output

Price

Output

ARAR

MRMR

MC MC

Elastic2demand2–consumers2responsive2to2small2price2changes2

Inelastic2demand2–high2willingness/2ability2to2pay

P1

Q1

P2

Q2

Price

Output

MR,off,peak

AR,off,peak

MC

P,off3peak

Q1 Q2

P,peak

MR,peak

AR,peak

PriceDiscriminationandEfficiency/WelfareTheWelfareCaseAgainstPriceTargeting

1. Exploitationoftheconsumer–themajorityofconsumerstillpaymorethanmarginalcost2. Extractionofconsumersurplusturnedintohigherproducersurplus/supernormalprofit3. Possibleuseofdiscriminationasalimitpricingtactic/andabarriertoentrytorivalfirms4. Ultimately,ifsuccessful,itreinforcesthemonopolypower/dominanceofexistingfirms

ArgumentsinSupportofPriceTargeting

1. Potentialforcrosssubsidyofactivitiesthatbringsocialbenefitsi.e.chargingmuchlowerpricesfordrugsinlower&middle-incomecountries

2. Makingbetteruseofsparecapacity–thiscanhaveenvironmentalbenefits–lesswaste3. Itbringsnewconsumersintomarket–whowouldotherwisebeexcludedbya‘normal’

higherprice4. Useofmonopolyprofitforresearch–thisisastimulustoinnovation/dynamicefficiency

gains