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- [Tyler] In our last video,

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we saw that price discrimination[br]is good for the monopolist.

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It increases profits,

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but what about [br]for society as a whole,

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does price discrimination[br]increase social welfare?

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That's the topic of today's talk.

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It's complicated, but here's[br]a rule of thumb --

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if price discrimination[br]increases output

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then it's very likely[br]to be beneficial,

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to increase social welfare.

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If output, however,[br]does not increase

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then welfare probably is reduced.

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Let's give some intuition

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for when price discrimination[br]increases welfare.

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Think about our previous example

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of the pharmaceutical company GSK

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setting a high drug price in Europe

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and a lower drug price in Africa.

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Suppose that GSK were forced[br]to charge only one price.

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Do you think it would charge

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closer to the European price[br]of $12.50 per pill

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or closer to the African price[br]of 50 cents per pill?

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What's more likely to happen

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if GSK is required[br]to set only one price?

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If they can't price discriminate,

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GSK very likely will simply abandon[br]the African market

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where they weren't making[br]that much profit anyway

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and set a single world price

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pretty close to the European level.

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People sometimes think that[br]if only everyone were allowed

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

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Mexico or Africa[br]where they're cheaper,

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then we would all enjoy[br]lower prices.

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Probably not.

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Smuggling or illegal re-importation[br]of pharmaceuticals

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were to become more common,

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then pharmaceutical companies[br]would stop price discriminating

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and set higher prices for everyone.

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Who would be made better off[br]by the resulting single price?

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Well, Europeans are not better off

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because they're still paying[br]a high price

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under the single price rule,

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but Africans are going[br]to be worse off,

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because they will no longer[br]have the option

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of buying important drugs[br]at the lower prices.

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In this case,[br]price discrimination is beneficial

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because it increases output.

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It gives some Africans[br]the chance to buy at a lower price

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when they otherwise would not[br]have had that chance

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under a no price discrimination rule.

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For industries[br]with high fixed costs,

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price discrimination[br]has another benefit -

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the extra profits generated[br]by price discrimination mean

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that it's more profitable[br]for the company

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to engage in research[br]and development

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to produce more new drugs[br]for instance.

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For example, the extra profits[br]from selling in Africa

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mean that research and development[br]is more profitable,

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and that benefits Europeans too.

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When it comes to new drugs,

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you might say that misery[br]loves company.

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That is, the larger the market[br]for a potential drug,

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the more research[br]and development will be applied.

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Price discrimination similarly[br]means airlines can offer

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more flights to more places[br]at better times,

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and that also helps business people.

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Even though they're paying[br]the higher prices,

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they have a better chance[br]at being able to get there

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at a good time in the first place.

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When it comes to software,[br]lower prices for the students

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also is going to help[br]support software R&D.

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If the students wouldn't buy[br]the software at all

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at the higher price,[br]well then the price discrimination

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is a net benefit[br]to pretty much everyone.

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More generally, price discrimination[br]can help spread the fixed costs

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of research and development[br]over a larger population,

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and that means more innovation

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which is to virtually[br]everyone's benefit.

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The ultimate form[br]of price discrimination

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is when each person is charged

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his or her maximum[br]willingness to pay.

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Economists call this[br]“perfect price discrimination.”

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Under perfect price discrimination,

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consumers end up[br]with zero consumers surplus.

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All of the gains from trade[br]go to the monopolist,

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but the efficient quantity[br]is produced.

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There's no deadweight loss.

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Let's look at this with a diagram.

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Think of the demand curve as showing[br]the maximum willingness to pay

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by different individuals to buy[br]a single unit of this good.

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Here, for example,[br]is Alex's willingness to pay.

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Here's Tyler's willingness to pay,[br]Robin's, and on,

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all the way down to Brian's[br]willingness to pay for the good.

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If the monopolist could charge[br]each and every consumer

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his or her maximum[br]willingness to pay,

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the monopolist would walk[br]down the demand curve

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producing each unit such[br]that the willingness to pay

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just exceeded the marginal cost.

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In other words, the monopolist[br]would produce every unit

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up until the efficient[br]quantity of output,

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

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The difference being that[br]in the competitive industry,

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the gains would go[br]to the consumers.

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In the case of[br]perfect price discrimination,

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all the gains go to the monopolist.

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

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a lot of information[br]about each consumer.

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Are there examples[br]of this in practice?

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In fact there are some,

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and you may be very familiar[br]with one of them.

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Universities are fabulous[br]price discriminators.

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They're even better than the airlines,

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

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Universities give many students[br]financial aid,

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which is another way[br]of saying that they charge[br]

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some of their students[br]more than others.

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Financial aid is a way[br]of doing well while doing good

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because it's a form[br]of price discrimination.

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It increases profits[br]for universities.

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Moreover, to get the aid,

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students and their parents[br]must give the university

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an incredible amount[br]of financial information,

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including their tax forms,[br]their W2's,

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information[br]about their bank accounts,

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the home they own and so on.

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All of this information means [br]the universities can create

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many, many different prices

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

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At Williams College for instance,

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half the students pay full fare,

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which is about $32,000 a year.

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The other half gets some form[br]of financial aid,

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but the amount varies tremendously.

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Students whose parents have incomes[br]of about $91,000 a year or higher,

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they pay an average in tuition[br]of about $22,000 a year.

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While students[br]from very poor families

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may pay as little as $1,600 a year.

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That's meaning[br]that one price can be

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about 20 times higher[br]than the other.

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That's a lot of price discrimination.

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Price discrimination makes[br]a lot of sense for universities

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because their marginal costs are low

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while their fixed costs[br]are pretty high.

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If a professor is teaching[br]Economics 101 anyway,

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then the marginal cost of putting[br]an extra student in the classroom

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is pretty close to zero.

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Even a student who is paying[br]a smaller amount in tuition

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is probably adding more[br]to profits than to costs.

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That helps the university[br]cover its fixed costs

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such as the salaries[br]and the buildings

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necessary to support[br]the operations of the university.

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So again, price discrimination[br]by the universities

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increases profits,

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but it also probably increases[br]their output as well.

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More students attend university[br]than otherwise would be the case.

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And again, price discrimination[br]also helps to spread the fixed costs

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around a larger number[br]of customers.

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For these reasons,[br]price discrimination by universities

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probably increases social welfare.

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That's it for the more obvious[br]forms of price discrimination.

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In the next talk we'll be looking at

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some quite common[br]pricing strategies,

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such as tying and bundling,

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which also can be understood

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as more subtle forms[br]of price discrimination.

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- [Announcer] If you want[br]to test yourself,

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click “Practice Questions.”

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

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