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ECO100 - NOV 14 Price Discrimination, inefficiency of monopolies, deadweight loss

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James Pesando

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5. Price Discrimination:ATool to Increase Profits New York Times Article ● Publishers set different prices for textbook in different geographic market (higher in north america; lower in europe) Why? Example #1 ● Let MC = ATC = $1 to produce a widget ○ There are no fixed costs - only way for MC = ATC when MC is constant ● Market research shows that: information about your demand curve ○ 1,000 A customers: will pay $20 ○ 5,000 B customers: will pay $5 ● How to maximize profit? You have enough market power to set the price. ● Strategies for the firm: ○ 1) P=20 Profits: 1,000*(20-1) = 19,000 ○ 2) P=5 Profits: 1,000*(5-1) = 4,000 ○ + 5,000*(5-1) = 20,000 ○ = 24,000 ■ Setting the low price earns your more profit ○ 3) P=20 for A customers P=5 for B customers => Price discrimination ■ Selling the same product at a different price to different customers ■ Profits: 1,000*(20-1) = 19,000 ■ + 5,000*(5-1)= 20,000 ■ = 39,000 ● Intuition: Increases profits by permitting monopolist to sell additional output without lowering the price. ○ If this monopolist can price discriminate, it is not forced to lower the price. ● Result: Monopolist will charge high price to customers with low price elasticity of demand (inelastic, less than 1) and low price to customers with high price elasticity of demand (elastic, greater than 1) ○ If there are some way to divide your customers by their elasticity of demand. ● Requirement: Monopolist must be able to segment (separate) its customers. Must be able to stop from customers reselling. ○ If customers with high price elasticity of demand buy at “low” price and then resell at “low” price to other customers, price discrimination fails. ○ The texbook seller segmented the market geographically. ○ The student took advantage of arbitrage. Example #2 ● Why do store issue coupons, in newspapers or flyers on the web, which permit buyers to obtain a price discount? (Most individuals ignore these coupons) ● Answer: price discrimination ● Buyers who use coupons: high elasticity of demand ○ Buy at discounted, lower price ○ Would not buy at a higher price ● Buyers who do not use coupons: low elasticity of demand ○ buy at full, higher price ○ Willing to buy at the full price ● Stores can increase their sells ○ 1. Those who are willing to pay. ○ 2. Those who will buy or buy more when they can get a discount relative to the market price. ● This type of price discrimination works - increase profits. ● Allow different customers to pay different prices for the same product. Example #3 ● Would a shirt manufacturer ever rip threads to create imperfect shirts? ● Clothing manufacturer often have two retail outlets. ○ Regular stor
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