PRICE DISCRIMINATION

When firms have market power, they can sometimes increase their profits through price discrimination. Price discriminating occurs when the same product 15 sold to different consumers for different prices. Consider the following example. You run it. company selling a successful personal-finance program called My Money. marketing manager comes In and says:, Look, boss. Our market research shows that our burrs fall into two categories-our current customers who are locked into My Money because their financial records have been kept using our program, and new buyers who have been using other programs.

Why don’t we raise our price to old customers and gi re a rebate to new customers who are to switch from our competitors? I’ve run the numbers. If we raise our price from $20 to $30 but give a $15 rebate for people who have been using other financial programs. we will make a bundle, You are intrigued by the suggestion and sketch the demand curves in Figure 1~5. Your research dedicates that your old customers have more price inelastic demand than your potential new customers because new customers must pay substantial switch bing costs. If your rebate program works and you succeed in segmenting the market, the numbers sh that your profits will rise from $1200 to $1350. (‘f, make sure you understand, the analysis, use the da shown in Figure 1~5 to estimate’ the monopoly price and profits if you set a single monopoly price and you price-discriminate between the two markets). Price discrimination is widely used today. particularly with goods that are not easily transferred from the low-priced market to the high-priced market. Here are some examples:

• Identical textbooks are sold at lower prices in Europe than in the United States. What prevents wholesalers from purchasing large .quantities abroad and undercutting the domestic market? A protectionist quota prohibits the practice. However. as an individual. you might well reduce the costs of your books by buying them abroad through online bookstores.

• Airlines are the masters of price discrimination (review our discussion of “Elasticity Air” in Chapter 4). They segment the market by pricing tickets
differently for those who travel in peak or off peak times. for those who are business or pleasure travelers. and for those who are willing to stand by. This allows them to fill their planes without eroding revenues.

• Local utilities often use “two-part prices” (sometimes called nonlinear prices) to recover some of their overhead costs. If you look at your’ telephone or electricity bill, it will .generally have a “connection” price and a “per-unit” price of ice. Because connection is much more priceinelastic than the per-unit price. such two-part pricing allows sellers to lower their per-unit prices and increase the total quantity sold.

• Firms engaged in international trade often find that foreign demand is more elastic than domestic demand. They will therefore sell at lower prices abroad than at home. This practice is called “dumping” and is sometimes banned under international-trade agreements.

• Sometimes a company will actually degrade its to porf- the-line product to make a less capable product.which it will then sell at a discounted price to capture a low price market. For example. IBM inserted special commands to slow down its laser printer from 10 pages per minute to 5 pages per minute so that it could sell the slow model at a lower price without cutting into sales of its top model. You should make a list of the different kinds of price discrimination that you can find. You will be surprised at the prevalence of this practice. What are the economic effects of price discrimination? Surprisingly. they often improve economic welfare. To understand this point. recall that monopolies raise their price and lower their sales to increase profits. In doing so. they may capture the market for eager buyers but lose the market for reluctant buyers. By charging different prices for those willing to pay high prices (who get charged high prices) and those willing to pay only lower prices (who may sit in the middle seats or get a degraded product. but at a lower price). the monopolist can increase both . its profits and consumer satisfactions.’

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