Price Discrimination

Carmel Secondary School

• 1. same product with• 2. same production costs to• 3. different buyers at• 4. different prices

Price Discrimination (PD) is seller selling the….

E.g.

Similar chicken withsame production cost to

different buyers with different prices at the

same place .

Why does PD exists?Why does PD exists? PD exists because sellers want to extract consumer surplus

However, to impose price discrimination ,sellers have to fulfill several conditions …

In EconomicsIn Economics, there are two models explaining , there are two models explaining PD ,one is from economist PD ,one is from economist George Strigler , ,Another one is from economist Another one is from economist Steven Cheung . .

• Seller must have monopoly power over the product ;

• Buyers must have different price elasticity on the same product ; (willing to pay different price)

•Markets can be separated . (resell is prevented)

• Seller have lower Information cost than buyer . (buyer willing to pay higher price : cost of obtaining information > loss in paying higher price)

• Information costs include those costs of obtaining information of trade .

The gain in using PD

(extracted consumer surplus)

>

Transaction cost of using PD

Or

The two models both try to explain the fact of PDFurthermore, seller will only use PD

when transaction cost incurred is insignificant

There are two types PD :

• 1.First degree PD (extract all CS) - charging along demand curve - required perfect knowing on buyers’ MUV

• 2.Third degree PD (extract part of CS) - charge different prices of same product on - different buyers with independent demands

Case 1

Price Discrimination caused by the difference

in price elasticity of demand

My son , Do you know why I have to pay more than

you while traveling by MTR and ?

Oo…is it the MTR and impose a price discriminati

on on us?

CASE 1

Can you try to explain further?

Ok !

Mummy , let me try to explain…According to Dr George

Strigler,Different buyers have different price elasticity of demand.

In order to impose price discrimination, the

MTR company has to separate the market into

student and adult markets.

Students are more price elastic than adult,

because their time cost are relatively lower, if

MTR charge them a high price, they will choose other substitutes. So

MTR charge them with a lower price.

To identify students, MTR give students a

Student Travel Card. So MTR can separate the markets successfully.

So students can pay a lower price than

adult !! Since the cost of serving them is the same, so it is price

discrimination .

Case 1

Well done ! You are so smart .I give this chicken leg to you .

YEAH

CASE 1

Case 2

Price Discrimination caused by Information

costs

Why is this tourist willing to pay a much higher price than me for

the same product ?

Temple StreetTemple StreetCase 2Case 2

Tourist

Dear sister….would you mind telling me why tourist always

willing to pay such a high price for the

goods in Hong Kong??It is because their

information cost is relatively higher than locals …..So the sellers price discrimination

them ….

Information cost ??

What’s that ??

WELL…Let me explain it to

you…..

According to Dr. Steven Cheung, one

who has a higher information cost is

more likely to be price discriminated by a

seller .

As the cost of obtaining information is high…buyer with high information cost

will be willing to pay a higher price .

It results a price discrimination then….

Then…..are all tourists have high information cost

and eventually lead to PD ?

Well…baby…..the answer is “ NO ” !

Let me illustrate it with an example…

Case 2Case 2

Example

Tourist

SellerI am just returned

from USA and I will stay here for 3

months…..Yet I want to buy a camera

first…..

Ooo….he is a tourist ….he must have a high infor

mation cost….I can charge him a high price then….

hehe

Hi…..I know you are a tourist….You just

come to a right place….You can find everything here….and

their prices are reasonable….

Waaaaa…..he must think I am a tourist and necessary to have a high information cost….so he wants to

price discriminate me…..

However, I’m going to stay in Hong Kong for 3 months.

My time cost of obtaining information is much lower

than a normal tourist because I have a lot of time

to search information.

So ….my information cost is not high ….Haha…..he want to charge me a high price ?!…NEVE

R !!

Sorry …I don’t think the price of your

products is suitable for me….Bye Bye

So ….tourists are not necessary to have high

information costs…Information costs

contain various costs…. local people may also have high information

costs…..

If they give up the chance of continuing their tours to obtain

information….they may even suffer a high loss……..That’s why they are

willing to pay more .

Case 2Case 2

However…how can you ensure a local people can buy the same product as the tourist at the same place with a cheaper

price ?? If a local people just buy at the same price…..it is not

price discrimination….

Well…baby…we can’t ensure it…but a local people usually get more

information than a tourist about the local market …. So their bargaining

power are usually higher….So it is less likely to pay a

higher price…. price discrimination then

exists ??

Exactly baby….!!

In many cases just like this example ,normally, tourist have high information cost are because their time cost is very high .They lack time

to obtaining sufficient information….

……….……….

Ok ….I see….

CASE 3

May I ask you one question??

PD are divided into 1st and 3rd degre

e PD? Isn’t it ?

……………Are you talking about first degree and third degree PD ?YES !

Well ! Aunt do you know what is first degree PD?

Good question !Let see .Of course….

$/P

Q0

MR

MC

P

AR=D=MV

Qd

= consumer surplus

AV

CASE 3

Fig 1

Simple monopoly pricing

Refer to Fig 1Originally, the seller produce when MC cut MR at Qd and

price is P….Then….. the Red area will be

the consumer surplus….

A

(1st Degree)

Simple monopoly pricing

$/P

Q0

MC

AR=D=MV

Qd

= consumer surplus

AV

CASE 3

Fig 2

=PP2

Q2

MR

P3

BSo, charging the

area P20Q2B is the same as charging

the area P30Q2A…..

Since mathematical proved that two

yellow triangles are identical ….

Haha….Do you understand what is 1st Degree PD?

However, under 1st PD ,AR curve of Simple monopoly

pricing (SMP) will equal to MR and MV curve .

AV curve of SMP will equal to AR curve ……

Therefore, this time not only part of

consumer surplus, but whole of it will be

captured by seller !!

The seller charges buyers with the

area P20Q2B ……

Again….seller will produce at MC cut MR…

Also…..the seller has to prevent resale

among buyers…..It may require a very

high transaction cost in doing so…..

However,1st PD is a very extreme case…the seller

require……

CASE 3

It is impossible in the real world . How can a seller know all about

his buyer’s preference?

Therefore….it is difficult to find a real example to

illustrate it !

Question 1

If a doctor charges his clients the same service charge and sells them the same medicines with

different prices, is it considered as a kind of PD?

A. Yes B. No

The answer is “YES” not because the service charge, but the different prices for the medicines. For the cost of buying and

distributing/selling these medicines are the same, charging different clients with

different prices is a kind of PD.

Question 2

Is the telephone company charges more for IDD calls during rush hours practicing

price discrimination ?

A. Yes B. No

The answer is “NO” .Since the cost of providing IDD services is higher

during rush hours (the workload of the computer servers maybe higher) .For a

higher cost…charging a higher price is not PD .

Question 3

A can of soft drink is sold at a higher price in a hotel than in a

supermarket .Is this price discrimination?

A. Yes B. No

The answer is “NO”.As the hotel mainly serves tourist,

the cost of serving them is usually higher (e.g. waiters are always required to have good English speaking skills )

For a higher serving cost,Charging a higher price is not PD.

From sellers’ point of view,if the gain of practicing PD from trade can cover the transaction cost involved, we had better to

practice PD to capture consumer surplus.

Price discrimination can be divided into 1st Degree and

3rd Degree price discrimination.

There are many example of PD in our live such as MTR .

You can find them out if you pay more attention.

However , to practice or not depends on the transaction cos

t involved .

Price discrimination can help seller to extract consumer surplus .

There are two model of economics in explaining PD, one from Professor George Strigler, one from Professor

Steven Cheung.

2001-2002

Carmel Secondary School6B Chan Chung Hon

6B Poon Tai Yin6B Yip Tsz To