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- In our last video, we saw that price[br]discrimination is good for the monopolist.

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It increases profits, but what about for[br]society as a whole, this price

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discrimination increase social welfare?[br]That's the topic of today's talk.

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It's complicated but here's a rule of[br]thumb, if price discrimination increases

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output then it's very likely to be[br]beneficial to increase social welfare, if

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output however does not increase then[br]welfare probably is reduced. Let's give

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some intuition for when price[br]discrimination increases welfare. Think

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about our previous example of the[br]pharmaceutical company GSK setting a high

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drug price in Europe and they lower drug[br]price in Africa. Suppose that GSK were

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forced to charge only one price. Do you[br]think it would charge closer to the

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European price of $12.50 per pill or[br]closer to the African price of 50 cents

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per pill? What's more likely to happen if[br]GSK's required to set only one price? If

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they can't price discriminate, GSK very[br]likely will simply abandon the African

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market for they weren't making that much[br]profit anyway and set a single world price

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pretty close to the European level. People[br]sometimes think that if only everyone were

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aloud to import pharmaceuticals to the[br]United States from Canada, Mexico or

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Africa where they're cheaper then we would[br]all enjoy lower prices. Probably not.

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Smuggling or illegal re-emportation of[br]pharmaceuticals were to become more common

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than pharmaceutical companies would stop[br]price discriminating and set higher prices

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for everyone. Who would be made better off[br]by the resulting single price? Well,

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Europeans are not better off because[br]they're still paying a high price under

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the single price rule, but Africans are[br]going to be worse off.

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Because they will no longer have the[br]option of buying important drugs at the

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lower prices. In this case, price[br]discrimination is beneficial because it

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increases output. It gives some Africans[br]the chance to buy at a lower price when

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they otherwise would not have had that[br]chance under a no price discrimination

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rule. For industries with high fixed costs[br]price discrimination has another benefit,

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the extra profits generated by price[br]discrimination mean that it's more

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profitable for the company to engage in[br]research and development to produce more

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new drugs for instance. For example the[br]extra profits from selling in Africa mean

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that research and development is more[br]profitable, and that benefits Europeans

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too. When it comes to new drugs, you might[br]say that misery loves company. That is the

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larger the market for a potential drug the[br]more research and development will be

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applied. Price discrimination similarly[br]means airlines can offer more flights to

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more places at better times, and that also[br]helps business people. Even though they're

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paying the higher prices, they have a[br]better chance at being able to get there

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at a good time in the first place. When it[br]comes to software, lower price is for the

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students also is going to help support[br]software R and D. If the students wouldn't

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buy the software at all at the higher[br]price, well, then the price discrimination

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is a net benefit to pretty much everyone.[br]More generally price discrimination can

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help spread the fixed costs of research[br]and development over a larger population

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and that means more innovation which is to[br]virtually everyone's benefit. The ultimate

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form of price discrimination is when each[br]person is charged his or her maximum

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willingness to pay. Economist call this[br]'perfect price discrimination,' under

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perfect price discrimination consumers end[br]up with zero consumers surplus. All of the

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gains from trade go to the monopolist, but[br]the efficient quantity is produced.

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There's no dead weight loss. Let's look at[br]this with a diagram. Think of the demand

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curve as showing the maximum willingness[br]to pay by different individuals to buy a

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single unit of this good. Here for example[br]is Alex's willingness to pay, here's

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Tyler's willingness to pay, Robin's and on[br]all the way down to Brian's willingness to

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pay for the good. If the monopolist could[br]charge each and every consumer his or her

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maximum willingness to pay, the monopolist[br]would walk down the demand curve producing

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each unit such that the willingness to pay[br]just exceeded the marginal cost. In other

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words the monopolist would produce every[br]unit up until the efficient quantity of

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output, the same quantity as would be[br]produced by a competitive industry. The

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difference being that in the competitive[br]industry the gains would go to the

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consumers. In the case of perfect price[br]discrimination, all the gains go to the

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monopolist. This kind of price[br]discrimination requires that the

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monopolist have a lot of information about[br]each consumer. Are there examples of this

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in practice? In fact there are some, and[br]you maybe very familiar with one of them.

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Universities are fabulous price[br]discriminators. They're even better than

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airlines, especially because few people[br]realize what is actually going on.

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Universities give many students financial[br]aid, which is another way of saying that

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they charge some of their students more[br]than others. Financial aid is a way of

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doing well while doing good because it's a[br]form of price discrimination. It increases

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profits for universities. Moreover to get[br]the aid, students and their parents must

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give the university an incredible amount[br]to financial information, including their

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tax forms, their W2's, information about[br]their bank accounts, the home they own and

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so on. All of this information means the[br]universities can create many many

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different prices in a way that approaches[br]perfect price discrimination.

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At William's College for instance, half[br]the students pay full fare. Which is about

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$32,000 a year, the other half gets some[br]form of financial aid but the amount

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varies tremendously. Students whose[br]parents have incomes of about $91,000 a

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year or higher, they pay an average[br]intuition of about $22,000 a year. While

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students from very poor families may pay[br]as little as $1,600 a year. That's

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meaning that one price can be about 20[br]times higher than the other, that's a lot

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of price discrimination. Price[br]discrimination makes a lot of sense for

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universities because their marginal costs[br]are low while their fixed costs are pretty

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high. If a professor is teaching[br]economics 101 anyway, then the marginal

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cost of putting an extra student in the[br]classroom is pretty close to zero. Even a

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student who is paying a smaller amount in[br]tuition is probably adding more to profits

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than to costs. That helps the university[br]cover its fixed costs such as the salaries

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and the buildings necessary to support the[br]operations of the university. So again

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price discrimination by the universities[br]increases profits but it also probably

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increases their output as well. More[br]students attend university then otherwise

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would be the case. And again, price[br]discrimination also helps to spread the

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fixed costs around a larger number of[br]customers. For these reasons, price

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discrimination by universities probably[br]increase the social welfare. That's it for

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the more obvious forms of price[br]discrimination. In the next talk we'll be

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looking at the some quite common pricing[br]strategies, such as tying and bundling,

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which also can be understood as more[br]subtle forms of price discrimination.

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- If you want to test yourself, click[br]practice questions.

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Or, if you're ready to move on,[br]just click 'next video.'

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