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BEE2017BEE2017 Intermediate Intermediate Microeconomics 2Microeconomics 2Price and product Price and product

discrimination discrimination

Dieter BalkenborgDieter Balkenborg

Todd KaplanTodd Kaplan

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Timetable Timetable

Lectures (Todd and Dieter):Lectures (Todd and Dieter):– Tuesday 12:00-13:00, STC/ATuesday 12:00-13:00, STC/A– Thursday 16:00-17:00, STC/AThursday 16:00-17:00, STC/A

Help Hour (Miguel Fonseca)Help Hour (Miguel Fonseca)– Tuesday 16:00-17:00, LAV/LT6 (starts next week)Tuesday 16:00-17:00, LAV/LT6 (starts next week)

Experiments (Miguel + Pricilla Marimo + Sara Experiments (Miguel + Pricilla Marimo + Sara Talloo) starts next week. Please sign up!Talloo) starts next week. Please sign up!– Tuesday 11:00-12:00 STC/116.Tuesday 11:00-12:00 STC/116.– Friday 10:00-11:00 STC/116. Friday 10:00-11:00 STC/116.

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TextbooksTextbooks

Any modern intermediate Any modern intermediate microeconomics textbook is suitable. microeconomics textbook is suitable. There are free ones available on the There are free ones available on the web! web!

In particular: Nicholson et al.In particular: Nicholson et al.

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Summative AssessmentSummative Assessment

Exam in June 2 hoursExam in June 2 hours– 85 marks85 marks

AssignmentsAssignments– Aplia homework.Aplia homework.

Two per week starting next week: Two per week starting next week: One graded (after) and one not graded (before). One graded (after) and one not graded (before). Each counts equally towards 10 marksEach counts equally towards 10 marks

– Classroom and Homework experiments: Classroom and Homework experiments: Do 5 experiments with short questionnaire for 5 Do 5 experiments with short questionnaire for 5

marks. Experiments will rotated bi-weekly. You cannot marks. Experiments will rotated bi-weekly. You cannot repeat the same experiment. Priority to signups.repeat the same experiment. Priority to signups.

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First assignmentFirst assignment

A homework experiment on the A homework experiment on the FEELE websiteFEELE website

Access code: trk1-BEE2017aAccess code: trk1-BEE2017a Details will be announced on Details will be announced on

www.toddkaplan.com follow link to www.toddkaplan.com follow link to Undergraduate MicroUndergraduate Micro

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TopicsTopics

Price discrimination (Todd)Price discrimination (Todd) Auctions (Todd)Auctions (Todd) Imperfect Competition (Todd+Dieter)Imperfect Competition (Todd+Dieter) Game theory (Dieter)Game theory (Dieter) Asymmetric Information (Dieter)Asymmetric Information (Dieter) General equilibrium and welfare General equilibrium and welfare

theorems (Dieter)theorems (Dieter) Externalities and public goods Externalities and public goods

(Dieter)(Dieter)

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Simple MonopolistSimple Monopolist

Inverse demand is p=14-q and mc=2.Inverse demand is p=14-q and mc=2. Monopolist Profits=revenue-costs=(14-q)q-2qMonopolist Profits=revenue-costs=(14-q)q-2q Taking Derivative: Taking Derivative:

Marginal Revenue-marginal costs=14-2q-2Marginal Revenue-marginal costs=14-2q-2 This should equal zero. Thus,This should equal zero. Thus,

Marginal Revenue=marginal costsMarginal Revenue=marginal costs 14-2q-2=12-2q=014-2q-2=12-2q=0

Monopolist produces q=6 and the price is Monopolist produces q=6 and the price is p=14-6=8. Monopolist profit is 36.p=14-6=8. Monopolist profit is 36.

How does this look graphically?How does this look graphically?

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P=14-Q (inverse demand)

MRQM=6

PM=8

A

BC

MC=2

14

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Consumer Surplus with monopoly: A Producer Surplus with monopoly:BWelfare loss with monopoly: C

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Price DiscriminationPrice Discrimination Basic model: a monopolist charges:Basic model: a monopolist charges:

A. Same price for all units.A. Same price for all units.B. Same price to all customers.B. Same price to all customers.

Changing one or both of these is called Price Changing one or both of these is called Price Discrimination. Can one profit from this?Discrimination. Can one profit from this? 1st degree is different prices for both consumers 1st degree is different prices for both consumers

and units (both A and B are changed)and units (both A and B are changed) 2nd degree is different prices for different units (A 2nd degree is different prices for different units (A

changed).changed). 3rd degree is different prices to different 3rd degree is different prices to different

consumers (B changed).consumers (B changed).

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Homework ExperimentHomework Experiment

An example to learn all three types An example to learn all three types of price discriminationof price discrimination

Certainly relevant for the examCertainly relevant for the exam max 15 minmax 15 min Details on Details on www.toddkaplan.comwww.toddkaplan.com. .

Go to: FEELE, participant accessGo to: FEELE, participant access Access code: Access code: trk1-BEE2017atrk1-BEE2017a

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1st-Degree Price 1st-Degree Price DiscriminationDiscrimination

Different prices for both consumers and Different prices for both consumers and units.units.

To do this properly, a monopolist must To do this properly, a monopolist must have strong information on:have strong information on: Consumers’ preferences.Consumers’ preferences. Who is who.Who is who.

1st degree captures the whole 1st degree captures the whole consumer surplus.consumer surplus.

1st degree is efficient.1st degree is efficient.

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Effort to DiscriminateEffort to Discriminate

In 1990, IBM introduced the LaserPrinter E. In 1990, IBM introduced the LaserPrinter E. The difference was that it printed 5 ppm The difference was that it printed 5 ppm

rather than 10 ppm.rather than 10 ppm. They did so by ADDING 5 chips in the E They did so by ADDING 5 chips in the E

model. The purpose of the chips was to model. The purpose of the chips was to make the printer WAIT.make the printer WAIT.

The price of the new laserprinter E was The price of the new laserprinter E was 60% of the old one.60% of the old one.

Why did IBM pay for a reduction in the Why did IBM pay for a reduction in the speed?speed?

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Effort to Discriminate Effort to Discriminate ModelModel

Jim values the faster printer at 1000 and Jim values the faster printer at 1000 and the slower printer at 700.the slower printer at 700.

Sean values the faster printer at 700 and Sean values the faster printer at 700 and the slower printer at 600. the slower printer at 600.

It costs 450 to make the faster printer It costs 450 to make the faster printer and 475 to make the slower printer. and 475 to make the slower printer.

What should IBM charge for either What should IBM charge for either printer?printer? If IBM only sells the fast printer, what should it If IBM only sells the fast printer, what should it

charge?charge? If IBM wants to sell the fast printer to Jim and If IBM wants to sell the fast printer to Jim and

the slow printer to Sean, what is the max/min the slow printer to Sean, what is the max/min price difference. price difference.

What happens if the fast printer is priced at What happens if the fast printer is priced at 1000 and the slow printer 600?1000 and the slow printer 600?

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Other Examples of Effort to Other Examples of Effort to DiscriminateDiscriminate

Intel with its SX processors had the math Intel with its SX processors had the math coprocessor disabled.coprocessor disabled.

Fast delivery service may hold back packages Fast delivery service may hold back packages that are 2that are 2ndnd day rather than overnight. day rather than overnight.

Photo shops won’t give you films in 1 hour Photo shops won’t give you films in 1 hour even though they may be ready if you have even though they may be ready if you have ordered the longer service.ordered the longer service.

Sony Minidisc 60 minute vs. 74 minute Sony Minidisc 60 minute vs. 74 minute versions minidiscs are the same except for a versions minidiscs are the same except for a code on the 60 minute version written to stop code on the 60 minute version written to stop it from writing the longer time. it from writing the longer time.

Hard disks in MP3 players. Sometimes is Hard disks in MP3 players. Sometimes is cheaper to buy the MP3 player and take out cheaper to buy the MP3 player and take out the hard disk. People did this so they had to the hard disk. People did this so they had to take precautions.take precautions.

Cameras with 7 Megapixels have 3 Megapixels Cameras with 7 Megapixels have 3 Megapixels disabled. disabled.

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22ndnd degree Price degree Price DiscriminationDiscrimination

Ari values 1 umbrella at 10 pounds and has no Ari values 1 umbrella at 10 pounds and has no need for another umbrella.need for another umbrella.

Jodi values 1 umbrella at 11 pounds and also Jodi values 1 umbrella at 11 pounds and also values 2 umbrellas at 15 (together).values 2 umbrellas at 15 (together).

They each want to maximize the difference They each want to maximize the difference between their value and the price they pay.between their value and the price they pay.

What is the maximum a monopolist with zero What is the maximum a monopolist with zero marginal cost could make charging the same price marginal cost could make charging the same price per umbrella?per umbrella?

What is the max it could make charging a price for What is the max it could make charging a price for 1 and a special for two together?1 and a special for two together? Hint: what would happen if they charge 10 for one and 15 Hint: what would happen if they charge 10 for one and 15

for two?for two?

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Movie Release DatesMovie Release Dates Studios want to Studios want to

maximize maximize revenue.revenue.

Consumers must Consumers must decide when (if) decide when (if) to watch the film.to watch the film.

Consumers prefer Consumers prefer seeing the film seeing the film earlier but are earlier but are willing to pay willing to pay different different amounts.amounts.

Some prefer Some prefer different formats.different formats.

Venue weeks to releaseTheatrical Release 0Airlines+Hotels 16Home Video 27Home Pay-per-view 34Premium Cable/Sat. 61Network TV Huge var.

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Movie Release: A simple Movie Release: A simple model.model. There are only two formats: Theater and Home.There are only two formats: Theater and Home.

The home release can be The home release can be earlyearly or or latelate. The studio . The studio gets £5 for each Theater sale and £2 for each gets £5 for each Theater sale and £2 for each home viewer.home viewer.

Four Consumers. Four Consumers. AA only wants to see the movie in the theater. only wants to see the movie in the theater. BB only wants to see the movie at home. only wants to see the movie at home. C C will see the movie in the theater if the release is late. will see the movie in the theater if the release is late.

Otherwise, Otherwise, CC will see it at home. will see it at home. D D will see the movie at home only if only if the release is will see the movie at home only if only if the release is

early. early. What is studio profit for What is studio profit for earlyearly? ? LateLate? What should ? What should

the studio do? the studio do?

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Movie Release: further Movie Release: further analysisanalysis

After the studio announces release date and After the studio announces release date and the movie is released, what should it do?the movie is released, what should it do?

What stops this from happening each time? What stops this from happening each time? Consumers judge the release date not by Consumers judge the release date not by what the studio says, but by either previous what the studio says, but by either previous record or what the studio has incentive to record or what the studio has incentive to do.do.

Do you remember which studio produced Do you remember which studio produced the Titanic?the Titanic?

If consumers judge the industry as a whole If consumers judge the industry as a whole rather than individual studios, then what rather than individual studios, then what happens?happens?

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International Pricing of International Pricing of Pharmaceutical CompaniesPharmaceutical Companies

Prices of Prices of antipsychotic drug antipsychotic drug in various countries.in various countries.

Why such a Why such a difference?difference?

ClozapineAustria $59.92Belgium $75.62UK $294.93USA $317.03

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3rd-degree price 3rd-degree price discriminationdiscrimination

There are two groups of people that There are two groups of people that make up total demand D(p)=D1(p)make up total demand D(p)=D1(p)+D2(p).+D2(p).

Example: MC=0, D1(p)=100-p and Example: MC=0, D1(p)=100-p and D2(p)=60-p.D2(p)=60-p.

q=D1(p)+D2(p)=160-2p. q=D1(p)+D2(p)=160-2p. We find p=80-q/2. Marginal revenue is We find p=80-q/2. Marginal revenue is

80-q.80-q. MR=MC implies q=80 and p=40. MR=MC implies q=80 and p=40. Profit with one price is 3200.Profit with one price is 3200. MR in market 1 is 100-2*q1 and in MR in market 1 is 100-2*q1 and in

market 2 is 60-2*q2.market 2 is 60-2*q2.

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3rd-degree price 3rd-degree price discriminationdiscrimination

Find q1, q2, p1 and p2.Find q1, q2, p1 and p2. Show that combined profits are Show that combined profits are

2500+900=3400.2500+900=3400. At home: Try the same for D1(p)=100-p At home: Try the same for D1(p)=100-p

and D2(p)=100-p.and D2(p)=100-p. Need to ensure one group can’t sell to Need to ensure one group can’t sell to

another (leakage). another (leakage). Companies try to prevent leakage and Companies try to prevent leakage and

take advantage when it is limited: DVDs take advantage when it is limited: DVDs and camcorders (PAL vs. NTSC).and camcorders (PAL vs. NTSC).

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Examples of Price Examples of Price DiscriminationDiscrimination..

Book publisher having a cheap Book publisher having a cheap international edition of a book. international edition of a book.

How about paperbacks.How about paperbacks. Publisher charging libraries a higher Publisher charging libraries a higher

rate to libraries than to individuals. rate to libraries than to individuals. Frequent Flyer Programs.Frequent Flyer Programs. First Class Train tickets.First Class Train tickets. Saturday stayover for airfares.Saturday stayover for airfares.

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Two-Part TariffsTwo-Part Tariffs The sports center charges a fee to join and then a The sports center charges a fee to join and then a

per usage fee. per usage fee. Definition: A two-part tariff is a per unit fee, r,

plus a lump sum fee, F. Why don’t they just charge one or the other to Why don’t they just charge one or the other to

make it simple?make it simple? This “charges” demanders of a low quantity a

lower average price than demanders of a high quantity.

What form of price discrimination (if any) is this?What form of price discrimination (if any) is this? This is also the case with video games such as This is also the case with video games such as

the Xbox.the Xbox. Electric toothbrushes Electric toothbrushes

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Other two-part pricingOther two-part pricing Example: IBM and its punch cards Example: IBM and its punch cards

(overpriced). (overpriced). There are three types of consumers.There are three types of consumers.

– A is a heavy user and will make calculations A is a heavy user and will make calculations all day long: needs 100 punch cards.all day long: needs 100 punch cards.

– B is a light user and will need to make B is a light user and will need to make calculations only at the end of the day: calculations only at the end of the day: needs 50 punch cards.needs 50 punch cards.

– C is a hobbyist and would only fool around C is a hobbyist and would only fool around with the machine: needs 5 punch cards.with the machine: needs 5 punch cards.

The value of each calculation (using one The value of each calculation (using one card) is £100 (over the year). C values card) is £100 (over the year). C values owning the machine at £1000. The owning the machine at £1000. The machine costs £3000 to produce and machine costs £3000 to produce and punch cards £0.punch cards £0.

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Two-part tariff: punch cardsTwo-part tariff: punch cards

What is the monopoly’s profits if it What is the monopoly’s profits if it charges 0 for each punch card, r=0?charges 0 for each punch card, r=0?

What happens if the monopoly What happens if the monopoly charges 0 for the machine and only charges 0 for the machine and only for the punch cards, F=0?for the punch cards, F=0?

What happens if the monopoly What happens if the monopoly charges £1500 for the machine and charges £1500 for the machine and £70 for each punch card? £70 for each punch card? (F=1500,r=70)(F=1500,r=70)

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Other commentsOther comments

Sometimes there too high transaction Sometimes there too high transaction costs for two-part tariffs: Disneyland costs for two-part tariffs: Disneyland dilemma.dilemma.

Two-part tariffs could also be used for Two-part tariffs could also be used for surplus extraction rather than surplus extraction rather than discrimination. discrimination.

Example all customers are identical and have demand:– P = 14 - Q– MC = AC=2

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Example: Surplus Extraction w/ Two-Part Tariff

14

14 Q

P

2

12

72

Optimal two-part tariff:

(1) maximize surplus by r =2. (2) set F=surplus=72.

Why?

Note: Used in Franchises

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Bundling Bundling

Two types of people:Two types of people: A values $120 for Word, $100 for Excel.A values $120 for Word, $100 for Excel. B values $100 for a Word, $120 for Excel. B values $100 for a Word, $120 for Excel.

Microsoft has zero marginal cost.Microsoft has zero marginal cost.If Microsoft charges separately for each If Microsoft charges separately for each program, it can make $200 for each software program, it can make $200 for each software product for a total of $400.product for a total of $400.They could package both together (and stop They could package both together (and stop selling it individually) and sell it for $220 selling it individually) and sell it for $220 making a total profit of $440.making a total profit of $440.

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Anti-Competitive BundlingAnti-Competitive BundlingA library has £10,000 to spend on journals. A library has £10,000 to spend on journals. There are 10 good journals out there.There are 10 good journals out there.They want to buy as many journals as they can for the They want to buy as many journals as they can for the budget as long as each journal is less than £2000.budget as long as each journal is less than £2000.Six journals are owned by one publisher -E. Six journals are owned by one publisher -E. The 4 independent journals cost £1000 each.The 4 independent journals cost £1000 each.What is the maximum the E can make if it charges a What is the maximum the E can make if it charges a separate price for each (assume marginal cost is zero)?separate price for each (assume marginal cost is zero)?How about if E bundles all 6 together?How about if E bundles all 6 together?If E bundles all together, what can the independent If E bundles all together, what can the independent journals do?journals do?