Caⅴeats In practice, transactions costs and information constraints make this is difficult to implement perfectly(but car dealers and some professionals come close) Price discrimination won t work if consumers can resell the good Michael R Baye, Managerial Economics and Business Strategy, 3e. CThe McGraw-Hill Companies, Inc, 1999
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. , 1999 Caveats: • In practice, transactions costs and information constraints make this is difficult to implement perfectly (but car dealers and some professionals come close). • Price discrimination won’t work if consumers can resell the good
Second degree Price discrimination Price The practice of posting $10 MC a discrete schedule of declining prices for $8 different ql uantities $5 Example: Electric utilities 24 Michael R Baye, Managerial Economics and Business Strategy, 3e. CThe McGraw-Hill Companies, Inc, 1999
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. , 1999 Second Degree Price Discrimination • The practice of posting a discrete schedule of declining prices for different quantities. • Example: Electric utilities Price MC D $5 $10 4 Quantity $8 2
Third Degree Price discrimination The practice of charging different groups of consumers different prices for the same product Examples include student discounts, senior citizen's discounts, regional International pricing Michael R Baye, Managerial Economics and Business Strategy, 3e. CThe McGraw-Hill Companies, Inc, 1999
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. , 1999 Third Degree Price Discrimination • The practice of charging different groups of consumers different prices for the same product • Examples include student discounts, senior citizen’s discounts, regional & international pricing
Implementing Third Degree Price discrimination Suppose the total demand for a product is comprised of two groups with different elasticities EI<E 2 Notice that group l is more price sensitive than group Profit-maximizing prices P1=[E1/(1+E1)×MC 2=[E2(1+E2)×MC Michael R Baye, Managerial Economics and Business Strategy, 3e. CThe McGraw-Hill Companies, Inc, 1999
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. , 1999 Implementing Third Degree Price Discrimination • Suppose the total demand for a product is comprised of two groups with different elasticities, E1 < E2 • Notice that group 1 is more price sensitive than group 2 • Profit-maximizing prices? • P1 = [E1 /(1+ E1 )] MC • P2 = [E2 /(1+ E2 )] MC
An Example Suppose the elasticity of demand for Kodak film in the US is eu=-1. 5, and the elasticity of demand in Japan is e=-25 Marginal cost of manufacturing film is $3 Pu=[EU/(1+E×MC=[-1.5/(1-1.5)×$3=$9 PJ=[E/(1+E×MC=[25/1-2.5)×$3=$5 Kodak's optimal third-degree pricing strategy is to charge a higher price in the us, where demand is less elastic Michael R Baye, Managerial Economics and Business Strategy, 3e. CThe McGraw-Hill Companies, Inc, 1999
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. , 1999 An Example • Suppose the elasticity of demand for Kodak film in the US is EU = -1.5, and the elasticity of demand in Japan is EJ = -2.5 • Marginal cost of manufacturing film is $3 • PU = [EU/(1+ EU)] MC = [-1.5/(1 - 1.5)] $3 = $9 • PJ = [EJ /(1+ EJ )] MC = [-2.5/(1 - 2.5)] $3 = $5 • Kodak’s optimal third-degree pricing strategy is to charge a higher price in the US, where demand is less elastic