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♪ [music] ♪

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

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It increases profits, but what about 
for society as a whole, does price

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

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It's complicated, but here's a rule of
thumb - if price discrimination increases

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output then it's very likely to be
beneficial, to increase social welfare. If

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output, however, does not increase then
welfare probably is reduced. Let's give

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some intuition for when price
discrimination increases welfare. Think

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

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drug price in Europe and a lower drug
price in Africa. Suppose that GSK were

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

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

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

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

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market where they weren't making that much
profit anyway and set a single world price

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

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allowed to import pharmaceuticals to the
United States from Canada, Mexico or

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

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Smuggling or illegal re-importation of
pharmaceuticals were to become more common,

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then pharmaceutical companies would stop
price discriminating and set higher prices

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

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

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the single price rule, but Africans 
are going to be worse off,

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because they will no longer have the
option of buying important drugs at the

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

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

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

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rule. For industries with high fixed costs,
price discrimination has another benefit -

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

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

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new drugs for instance. For example, the
extra profits from selling in Africa mean

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that research and development is more
profitable, and that benefits Europeans

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

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larger the market for a potential drug, the
more research and development will be

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

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

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

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at a good time in the first place. When it
comes to software, lower prices for the

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students also is going to help support
software R&D. If the students wouldn't

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buy the software at all at the higher
price, well then the price discrimination

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is a net benefit to pretty much everyone.
More generally, price discrimination can

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help spread the fixed costs of research
and development over a larger population,

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

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

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willingness to pay. Economists call this
“perfect price discrimination.” Under

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perfect price discrimination, consumers end
up with zero consumers surplus. All of the

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

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There's no deadweight loss. Let's look at
this with a diagram. Think of the demand

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

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

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

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

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

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

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words, the monopolist would produce every
unit up until the efficient quantity of

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

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difference being that in the competitive
industry, the gains would go to the

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

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monopolist. This kind of price
discrimination requires that the

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

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in practice? In fact there are some, and
you may be very familiar with one of them.

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Universities are fabulous price
discriminators. They're even better than the

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

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

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

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

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

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give the university an incredible amount
of financial information, including their

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

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so on. All of this information means 
the universities can create many, many

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different prices in a way that approaches
perfect price discrimination.

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At William's College for instance, half
the students pay full fare, which is about

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$32,000 a year. The other half gets some
form of financial aid, but the amount

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

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year or higher, they pay an average
in tuition of about $22,000 a year. While

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

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meaning that one price can be about 20
times higher than the other. That's a lot

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of price discrimination. Price
discrimination makes a lot of sense for

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universities because their marginal costs
are low while their fixed costs are pretty

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high. If a professor is teaching
Economics 101 anyway, then the marginal

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

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

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

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and the buildings necessary to support the
operations of the university. So again,

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price discrimination by the universities
increases profits, but it also probably

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increases their output as well. More
students attend university than otherwise

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

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

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discrimination by universities probably
increases social welfare. That's it for

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

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

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

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- [Announcer] If you want to test yourself, 
click “Practice Questions.”

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Or, if you're ready to move on,
just click “Next Video.”

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♪ [music] ♪