Price discrimination

Suppose you can separate consumers into two groups:

Group 1 has a price elasticity of demand = -3 and group 2 has a price elasticity of demand of -9. If you could conduct third degree price discrimination, which group would you charge a higher price to? Why? What would be the relative price of group 1 to group 2? Suppose that the profit maximizing price for group 2 is $12. What price should I charge group 1?

Show all your work.

Notes:

Third Degree Price Discrimination = Charging two (or more) different prices to two (or more) different types of customers when MC is the same (or the difference in MC is not large enough to justify the difference in price). Price you charge for each group depends upon their “willingness to pay” - or their price elasticity of demand

Remember third degree price requires:

· Market Power

· Some means for identifying and separating customers based on their price elasticities of demand

· Prevent Arbitrage - restrictions on resale

Examples of Third Degree Price Discrimination

· Movies - Discount admission for children

· Different price elasticity for adults and children

· Resale restrictions?Examples of Third Degree Price Discrimination

· Movies - Discount admission for children

· Different price elasticity for adults and children

· Resale restrictions?

Other Examples of Third Degree Price Discrimination

· Senior citizen and Student Discounts

· Airline travel

· Coupons

· Hardcopy versus soft cover (note: MC will be different, but won’t capture the entire price differential)