Protein Shakes: Graph 1

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1 Protein Shakes: Graph Session 10 Explicit Price Discrimination Slide 1

2 Protein Shakes: Graph Session 10 Explicit Price Discrimination Slide 2

3 Protein Shakes: Graph Session 10 Explicit Price Discrimination Slide 3

4 Protein Shakes: Graph 4 Session 10 Explicit Price Discrimination Slide 4

5 Session 10 Explicit Price Discrimination Slide 5

6 Protein Shakes: Graph 5 Session 10 Explicit Price Discrimination Slide 6

7 Session 10 Explicit Price Discrimination Slide 7

8 Session 10: Explicit Price Discrimination 1. How prices depend on the demand curve (wrap up of Topic 9). 2. Charging different prices to different market segments (Topic 10). 3. Roxy Theater Session 10 Explicit Price Discrimination Slide 8

9 What happens to price after a shift in demand? (Price-sensitivity effect) If demand becomes less elastic, the firm will increase its markup over MC, higher prices. (Volume effect) (only if MC curve is increasing) If the MC curve is increasing and the firm increases output, then the resulting higher marginal cost higher prices. Session 10 Explicit Price Discrimination Slide 9

10 The price of a substitute good rises. What do you do? P d(p) Q Session 10 Explicit Price Discrimination Slide 10

11 What happened to airline prices just after September 11, 2001? Airlines Hold Back on Expected Fare Bonanza By Laurence Zuckerman and Joe Sharkey New York Times Service Despite a decline of as much as 50 percent in passenger traffic, major airlines have been reluctant to lower fares drastically after the terrorist attacks in the United States. Some bargains are being offered online by travel wholesalers and by small carriers, but the large fare sales that many analysts predicted have not materialized. The reason, airline executives said, is that fares had been discounted heavily before the attacks to try to counter an industry slowdown. But since the attacks, which involved four hijacked planes, many airlines are convinced that people are not ready to return to the skies at any price. Emotions are so high today that even a $99 coast-tocoast fare wouldn't do anything, said an executive at a major carrier who spoke on the condition of anonymity. People need a few weeks to realize that we are not being attacked on a daily basis. The major carriers have begun carrying out the 20 percent reductions in their schedules, which were announced last week to trim costs and to match reduced demand. Some are culling routes that were unprofitable before this month, or replacing large jets with smaller regional jets. But most are simply reducing the number of flights on existing routes. For example, both Delta Air Lines and US Airways have reduced their hourly shuttles from Boston to New York, which totaled as many as 17 flights a day, to just four flights a day each. Many airline executives and analysts acknowledged that they are guessing about the future because no one can be sure when airline traffic will return, particularly the lucrative business travel market, and at what level. The Air Transport Association, the industry's trade group, predicted that industry sales will be down 40 percent during the fourth quarter. But Samuel Buttrick, an airline analyst at UBS Warburg in New York, said he thought the number would be closer to 25 percent. The industry has little insight into what revenues will be in November and December, as do we, he said. The major airlines routinely decline to comment on future fares because of past allegations that they breached antitrust laws by signaling their pricing plans to competitors. But leisure fares are totally unpredictable said Alyse Ticker, the manager of Equinox Travel in Manhasset, New York. The airlines are scrambling. They're falling over themselves to entice customers back, she said. Many bargains are being offered quietly by Southwest Airlines and other aggressive low-fare carriers in markets away from the major hubs. Last week, one small carrier, National Airlines, which has about 50 flights a day, began offering round-trip fares as low as $25 between Las Vegas and San Francisco and Los Angeles, or $75 between New York City and Las Vegas. The major airlines have been cutting some fares on selected routes, often in response to their low-fare competitors. But they also are keeping a low profile about it. They're not advcrtising thcm, said Tom Parsons, thc president of Bestfares.com, an online travel site that specializes in booking discount fares. They're just loading them into the computer reservations systems. They're really hoping to avoid starting a major fare war that might spread competitively to the most lucrative business-travel routes from major hubs like New York, Chicago and Dallas. International Herald Tribune 26 September 2001, Page 2 Session 10 Explicit Price Discrimination Slide 11

12 Sometimes intuition isn t right Apple Slips as Result of Hoarding Chips WSJ, 30 Jan 1989 Apple Computer, which stockpiled hundreds of millions of dollars worth of precious memory chips during the height of a chip shortage last summer, said Friday that its strategy had backfired, and that as a result profit in its current quarter will fall by as much as 43%. Apple s cost of memory is $120 higher than current spot prices on a basic model and $480 higher on a fully loaded machine. The purchasing blunder was the first misstep in what Apple s chairman and chief executive office, John Sculley, concedes as a series of internal management and marketing decisions that, in hindsight, weren t very good decisions. Subsequent price increases aimed at shoring up profit margins squeezed by the expensive memory chips boomeranged, as customers and dealers instead bought stripped-down models of Apple s big-selling Macintosh computers and outfitted them with less-expensive additional memory chips and add-ons from other suppliers. Apple s misguided price increases after buying the expensive DRAMS might have permanently harmed its future sales of fully loaded computers. Deborah A. Coleman, the former chief financial officer, proposed raising prices across the board last fall. She is currently on leave and will return in July in a lesser role. Session 10 Explicit Price Discrimination Slide 12

13 Session 10: Explicit Price Discrimination 1. How prices depend on the demand curve (wrap up of Topic 9). 2. Charging different prices to different market segments (Topic 10). 3. Roxy Theater Session 10 Explicit Price Discrimination Slide 13

14 Setting different prices for different market segments Price-sensitivity effect for before and after demand curves (Topic 9) was derived from MR 1 = MR 2. So we get the same conclusion here: Set a higher price for the segment with less elastic demand. We do not need to assume constant marginal cost. The key assumption is that the segments are served from a common production facility, and hence the marginal cost of a unit is the same for whichever segment gets it. Session 10 Explicit Price Discrimination Slide 14

15 In which segment do you charge a higher price? P d 2 (P) d 1 (P) Q Session 10 Explicit Price Discrimination Slide 15

16 In which segment do you charge a higher price? P d 2 (P) d 1 (P) Q Session 10 Explicit Price Discrimination Slide 16

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19 Roxy case 18 P 18 P d 1 (P) 2 d 2 (P) Q Q Session 10 Explicit Price Discrimination Slide 17

20 Wrap up on Topic 10 - Explicit Price Discrimination Main point 1. Charge different prices to different groups of customers if possible and if the groups have different elasticities of demand. 2. Charge a higher price in the market with less elastic demand. On the course website, examples that illustrate Arbitrage need not be impossible. Consumer attitudes toward price discrimination. What do regulatory authorities say? Session 10 Explicit Price Discrimination Slide 18

21 Where are we? Firms are price-takers (Perfect competition) Firms have market power (Imperfect competition) (Sessions 1 6) Individual decisions Equilibrium Uniform pricing Price discrimination (Sessions 12 15) (Sessions 7 9) (Sessions 10 11) Session 10 Explicit Price Discrimination Slide 19

22 Price discrimination Topic 10 Explicit Price Discrimination Called 3rd-Degree Price Discimination in most texts 1. What? When? How? 2. Bottom line: Charge higher price to segment with less elastic demand. Topic 11 Implicit Price Discrimination (Screening) Not covered by most texts 1. Perfect price discrimination (benchmark) 2. Screening via differentiated products 3. Bundling Market power games start Mon or Tue. You will receive details by over the weekend. Session 10 Explicit Price Discrimination Slide 20