Summary Economics: Price Discrimination

EC3099 Units F & G: Price Discrimination


Contents
1. Overview of Price Discrimination 3
Necessary Conditions for Price Discrimination . . . . . . . . . . . . . . . . . . . . . . . . . 3
Economic Motivation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Types of Price Discrimination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Alternative Forms of Price Discrimination . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

2. First-Degree Price Discrimination 4
Definition and Setup . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Mathematical Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Welfare Effects of First-Degree Price Discrimination . . . . . . . . . . . . . . . . . . . . . 5

3. Third-Degree Price Discrimination 6
Setup and Market Structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Profit Maximization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Optimal Pricing Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Welfare Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Parallel Imports and Policy Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

4. Second-Degree Price Discrimination: Two-Part Tariffs 8
Basic Structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Practical Examples . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Identical Consumers Case . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Two Consumer Types . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Consumer Optimization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Monopolist’s Strategic Options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Key Insights from Two-Part Tariff Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Distortion and Efficiency Effects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

5. Fully Non-Linear Pricing 11
General Framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Construction Method: From Two-Part Tariff to Optimal Non-Linear Pricing . . . . . . . . 11
Formal Optimization Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Solution Structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
First-Order Conditions and Efficiency Results . . . . . . . . . . . . . . . . . . . . . . . . . 12
Key Results: No Distortion at the Top . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Practical Examples . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

6. Comparative Analysis and Policy Implications 14
Summary of Price Discrimination Types . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14


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,EC3099: Price Discrimination Units F & G: Page 2


Welfare Analysis Framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Policy Arguments and Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Strategic Use as Monopolization Device . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
International Trade and Parallel Imports . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

7. Advanced Topics and Extensions 16
Quality vs Quantity Discrimination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Dynamic Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Digital Age Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

Glossary 17

Notation and Symbols 18

Economic Models Reference Sheet 18

, EC3099: Price Discrimination Units F & G: Page 3


1. Overview of Price Discrimination
Price discrimination occurs when a firm charges different prices to different consumers not based
on cost differences, but based on differences in willingness to pay. It describes the strategies used
by firms to extract consumer surplus.

Necessary Conditions for Price Discrimination

Condition Explanation
Market power Firm can influence price (not a price taker)
Market segmentation Ability to identify different consumer groups
No arbitrage Resale between groups must be prevented


Economic Motivation
Different consumers have different valuations for the same product. Under standard monopoly
pricing, firms leave “unexploited surplus” on the table. Price discrimination allows firms to:
• Extract more consumer surplus without lowering prices to high-valuation consumers
• Potentially serve markets that would not be profitable under uniform pricing
• Increase total output in some cases
Key Principle: Optimal price depends on elasticity of demand. Firms charge higher prices to
consumers with lower price elasticity of demand.

Standard Monopoly: Unexploited Consumer Surplus



9 Consumer
Surplus Demand
Price




6 MR
Unexploited
Surplus

MC
3




0
0.0 2.5 5.0 7.5 10.0
Quantity

Figure 1: Monopoly Pricing and Unexploited Surplus