Third Degree Price

Discrimination
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Engr. Mary Jane A. Badillo
Price Discrimination

When a firm charges different prices for the
same good or service to different customers,
even though there is no difference in the cost
to the firm of supplying these consumers

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for it to be profitable.
Different price elasticities of demand must
exist in various submarkets

Able to efficiently identify relevant
submarkets and prevent transfers among
affected customers

Monitor customer buying patterns to prevent
reselling among customer subgroups
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With identical price elasticities and identical
marginal costs, profit maximizing pricing
policy calls for the same price and markup to
be charged in all market segment

Market segment division or fragment of the
overall market with unique demand or cost
characteristics

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Consumer Surplus
Is the value of purchased goods and services
above and beyond the amount paid to sellers

Arises because individual consumers place
different values on goods and services

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Consumer Surplus
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Conditions for Price Discrimination

The firm must operate in imperfect
competition, it must be a price maker with a
downwardly sloping demand curve.
The firm must be able to separate markets
and prevent resale.
Different consumer groups must have
elasticities of demand.
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Not every instance of firms charging different
prices to different customers constitutes price
discrimination
Price differentials based on difference in
production costs are not example of price
discrimination
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Price Discrimination
May be divided into three types

1. Personal seller charges different prices for
different persons
2. Local seller charges different prices for people
of different localities
3. According to use when the same commodity is
put to different users
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Industries that use price discrimination

Travel Industry prices fluctuate based on
time of travel
Pharmaceutical Industry drug-makers charge
more for drugs wealthier countries
Textbooks copyright protection laws increase
the price of textbooks
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Methods of price discrimination
Coupons allow price sensitive consumers to
receive a discount
Age discounts price of a good or admission
to an event is based on age
Occupational discounts when individuals
receive cerain discounts based on their
occupation
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Retail incentives includes rebates, discount
coupons, bulk and quantity pricing, seasonal
discounts and frequent buyer discounts

Gender based prices example is ladies night
at a bar
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Examples
Airline tickets

Products under different brand names or
labels

Providers of professional services

Manufacturers
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Publishers of academic journals

Student and senior citizen discounts

Retail and wholesale market

Movie houses


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Three Types of Price Discrimination
First degree perfect price

Second degree nonlinear, quantity discount

Third degree market separation
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First Degree Price Discrimination
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Second Degree Price Discrimination
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Third Degree Price Discrimination

May be employed when the firm cannot
identify individual demands but can identify
groups of cosumers that have similar demands
and can segment them
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Price Discrimination
Profitable because it allows the firm to
enhance revenues without increasing costs.

Effective means for increasing profits because
it allows the firm to more closely match
marginal revenues and marginal costs
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Price Discrimination

A firm that can segment its market maximizes
profits by operating at the point where
marginal revenue equals marginal cost in each
market segment
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Price Discrimination Example
Suppose that Midwest State University
(MSU) wants to reduce the athletic
departments operating deficit and increase
student attendance at home football games. To
achieve these objectives, a new two-tier pricing
structure for season football tickets is being
considered.
A market survey conducted by the school
suggests the following market demand and
marginal revenue relations:
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Public Demand
Pp = $225 $0.005Qp
MRp =
TRp
Qp
= $225 $0.01Qp

Student Demand
Ps = $125 $0.00125Qs
MRs =
TRs
Qs
= $125 $0.0025Qs

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During recent years, the football program
has run on an operating budget of $1.5 million
per year. This budget covers fixed salary,
recruiting, insurance, and facility-maintenance
expenses. In addition to these fixed expenses,
the university incurs variable ticket-handling,
facility- cleaning, insurance, and security costs of
$25 per season ticketholder. The resulting total
cost and marginal cost functions are

TC = $1,500,000 + $25Q
MC =
TC
Q
= $25
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What are the optimal football ticket prices
and quantities for each market, assuming that
MSU adopts a new season ticket pricing policy
featuring student discounts?
To answer this question, one must realize
that because MC = $25, the athletic
departments operating deficit is minimized by
setting MR = MC = $25 in each market segment
and solving for Q.
This is also the profit-maximizing strategy
for the football program.
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Therefore
Public Demand




and

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MRp = MC
$225 - $0.01Qp = $25
$0.01Qp = $200
Qp = 20, 000
Pp = $225 $0.005(20,000)
= $125

Student Demand




and

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MRs = MC
$125 - $0.0025Qs = $25
$0.0025Qs = $100
Qs = 40, 000
Ps = $125 $0.00125(40,000)
= $75
The football programs resulting total operating
surplus (profit) is
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Operating Surplus (Profit) = TRp + TRs - TC
= $125(20,000) +
$75(40,000) -
$1,500,000 -
$25(60,000)
= $2. 5 mi l l i on
Comparison with the One-Price
Alternative
If tickets are offered to students and the
general public at the same price, the total
amount of ticket demand equals the sum of
student plus general public demand. The
student and general public market demand
curves are

QP = 45,000 200PP and QS = 100,000 800PS
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Under the assumption Pp = Ps, total demand (QT)
equals


and

which implies that
MR =
TR
Q
= $145 $0.002Q

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QT = Qp + Qs
= 145,000 1,000P
P = $145 - $0.001Q
The uniform season ticket price that
maximizes operating surplus (or profits) is found
by setting MR = MC for the total market and
solving for Q:



and

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MR = MC
$145 - $0.002Q = $25
$0.002Q = $120
Q = 60, 000
P = $145 $0.001(60,000)
= $85
QP = 45,000 200PP QS = 100,000 800PS
= 45,000 200($85) = 100,000 800($85)
= 28,000 = 32,000
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Operating Surplus (Profit) = TR - TC
= $85(60,000) -
$1,500,000 -
$25(60,000)
= $2. 1 mi l l i on
Thank You
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