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Unit 4(c): Price Discrimination - Coggle Diagram
Unit 4(c): Price Discrimination
Welfare effects
First degree price discrimination will increase total welfare relative to uniform pricing, but consumer surplus would be greater in case of uniform pricing. The effects from second and third degree price discrimination are ambiguous. A useful point to remember is that price discrimination increases total sales, if this is the case does it harm consumers?
Price Discrimination is a general term that encompasses many ways of charging different prices. Discounts, rebates, bundling and tying, can to some extent constitute of price discrimination.
Some factors to consider when analysing such pricing:
Whether a dominant firm carries out, it can either deter entry or distort existing competition. Most often, the concern is with exclusion.
Most non-dominant firms carry out such practices.
Such practices cannot be deemed anti-competitive, there maybe many non-exclusionary motives for such pricing.
Different types of price discrimination:
(a) First degree price discrimination occurs when the seller knows exactly each consumer's Willingness to Pay.
There is no consumer surplus, all available economic surplus goes to the producer. However, this is pareto efficient and total welfare is maximised.
If price discrimination was not possible, firms may exercise market power by charging a price that is higher than MC. Output would be restricted at this price and there would be a section of consumers who would not be served even though they are willing to pay more than MC of producing further units.
(b) Second degree price discrimination allows consumers to self select from deals offered by the producer.
(c) Third degree price discrimination occurs where the supplier charges different prices to different customers based on their different observable characteristics
Price Discrimination involves charging different prices for different units of products where the cost of supplying the product remains the same. Alternatively, it may involve charging the same prices for different units of a product where the cost of supplying the product varies. Firms typically do this to capture the consumers' maximum Willingness to Pay.
While such discrimination maybe anticompetitive, it can also be pro competitive and have significant pro competitive benefits.
Conditions to Price Discriminate:
(1) Firm must charge a price above marginal cost, sometimes raising price above marginal cost can result in loss of sales. If all sales must occur at marginal cost, price discrimination is not possible.
This is sometimes described as a requirement for firms to have market power.
However, it is not necessary for firms to have market power to price discriminate, all they need is a downward sloping demand curve.
(2) There must be no arbitrage - if one customer can buy the same product at lower price and then incurs a less cost to resell the product to another customer then the firm's attempt at discrimination may be frustrated by arbitrage. There are some services where arbitrage may not be possible, in cases where they are not transferable or may not be resold, in this case arbitrage may be limited because one customer does not know what the other customer is getting.
(3) There must be some way to segment the market. In order to price discriminate, firms must be able to identify customers with different willingness to pay.
Benefits of Price Discrimination
Price paid according to willingness to pay
Expansion of output (paying lower discriminatory price can help increase sales, and hence output), also volume based discounts as well as output in two-sided markets
Recovery of fixed costs, where maintaining services like telecom can be expensive, uniform pricing can lead to a restriction in output. Therefore price discrimination can help in recovering fixed costs.
Dynamic incentives to invest: Where a firm is weighing costs and benefits of investing in a new product, the ability to extract a greater proportion of the consumer surplus.
Opening up new markets: In some cases, price discrimination may allow a new market to emerge.
Lower prices for all consumers, if there are enough suppliers in the market that earn zero economic profits.
Intensified competition - competition for each segment of the market increases.
Impact on downstream competition - A reduction in marginal costs faced by downstream firms will result in lower retail prices.
A ban on price discrimination could also include:
elimination of retailers' incentives to negotiate lower prices from suppliers. Where there is uniform prices, any reduction in prices to retailers will have to be given to all retailers.
may enable monopolists to extract full monopoly rents
How can price discrimination be anticompetitive?
(1) Exploitative
As discussed previously, price discrimination often involves charging high prices for those with higher willingness to pay. There will be winners and losers in such a strategy that is often zero sum. However, all the benefits of price discrimination must be considered, as well as the difficulties in analysing harm caused by excessive pricing.
(2) Exclusionary
If a dominant firm chooses to cut prices selectively wherever it faces competition, but leaving prices to other customers at a higher level, this can cause to deter entry or cause exit of competitors
the analysis is broadly similar to predatory pricing analysis
but there are slight distinctions:
price discrimination allows contemporaneous recoupment whereas predatory pricing usually involves a period of profit sacrifice followed by recoupment only when the exclusion has occurred.
How to distinguish from beneficial and harmful price discrimination ?
Equally efficient competitor test - if the incumbents price is above its cost base
some practical difficulties: first mover advantages, joint costs
Does the strategy constitute a profit sacrifice ?
Discounting and Rebates -
discounts form as an important factor of price competition
discounting can also help align incentives between buyers and sellers
discounting can also help in stimulating demand
There are two types of rebates : retroactive and incremental
How to test if retroactive rebates are anticompetitive?
Efficient competitor test : what level of sales is produced by the efficient competitor and whether it is plausible.
An AEC can survive as long as its price is total average cost.
Incremental rebates anti-competitive?
Incremental rebates below avoidable costs are likely to be anti-competitive
Incremental rebates above long run average incremental cost is unlikely to be anticompetitive
prices between avoidable and LRAIC may be anti-competitive if they foreclose AEC
Can the anti-competitive be recouped?