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♪ [music] ♪

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- [Tyler] In our last video,

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we saw that price discrimination
is good for the monopolist.

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It increases profits,

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but what about 
for society as a whole,

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does price discrimination
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
a rule of thumb --

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if price discrimination
increases output

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then it's very likely
to be beneficial,

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to increase social welfare.

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If output, however,
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
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
to charge only one price.

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Do you think it would charge
closer to the European price

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of $12.50 per pill

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

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What's more likely to happen

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if GSK is required
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
the African market

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where they weren't making
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
if only everyone were allowed

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to import pharmaceuticals
to the United States

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from Canada, Mexico, or Africa
where they're cheaper,

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then we would all enjoy
lower prices.

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Probably not.

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If smuggling or legal re-importation
of pharmaceuticals

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were to become more common,

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then pharmaceutical companies
would stop price discriminating

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and set higher prices for everyone.

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

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Well, Europeans are not better off

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because they're still paying
a high price

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under the single price rule,

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but Africans are going
to be worse off,

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because they will no longer
have the option

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of buying important drugs
at the lower prices.

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In this case,
price discrimination is beneficial

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because it increases output.

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

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when they otherwise would not
have had that chance

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under a no price discrimination rule.

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For industries
with high fixed costs,

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price discrimination
has another benefit --

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the extra profits generated
by price discrimination

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mean that it's more profitable
for the company

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to engage in research
and development

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to produce more new drugs
for instance.

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For example, the extra profits
from selling in Africa

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mean that research
and development 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
loves company.

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That is, the larger the market
for a potential drug,

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the more research
and development will be applied.

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Price discrimination similarly
means airlines can offer

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more flights to more places
at better times,

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and that also helps business people.

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Even though they're paying
the higher prices,

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they have a better chance
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,
lower prices for the students

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also is going to help
support software R&D.

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If the students wouldn't buy
the software at all

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at the higher price,
well then the price discrimination

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is a net benefit
to pretty much everyone.

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More generally, price discrimination
can help spread the fixed costs

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of research and development
over a larger population,

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and that means more innovation

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which is to virtually
everyone's benefit.

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The ultimate form
of price discrimination

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is when each person is charged

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his or her maximum
willingness to pay.

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Economists call this
“perfect price discrimination.”

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Under perfect price discrimination,

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consumers end up
with zero consumer surplus.

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All of the gains from trade
go to the monopolist,

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but the efficient quantity
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
the maximum willingness to pay

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

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

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Here's Tyler's willingness to pay,
Robin's, and on,

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

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If the monopolist could charge
each and every consumer

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his or her maximum
willingness to pay,

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the monopolist would walk
down the demand curve

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producing each unit such
that the willingness to pay

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just exceeded the marginal cost.

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In other words, the monopolist
would produce every unit

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up until the efficient
quantity of output,

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

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The difference being that
in the competitive industry,

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the gains would go
to the consumers.

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In the case of
perfect price discrimination,

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all the gains go to the monopolist.

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This kind of price discrimination
requires that the monopolist

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have a lot of information
about each consumer.

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Are there examples
of this in practice?

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In fact there are some,

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and you may be very familiar
with one of them.

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Universities are fabulous
price discriminators.

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They're even better than the airlines,

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especially because few people
realize what is actually going on.

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Universities give many students
financial aid,

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which is another way
of saying that they charge


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some of their students
more than others.

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Financial aid is a way
of doing well while doing good

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because it's a form
of price discrimination.

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It increases profits
for universities.

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Moreover, to get the aid,

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students and their parents
must give the university

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an incredible amount
of financial information,

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including their tax forms,
their W2's,

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information
about their bank accounts,

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the home they own and so on.

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All of this information means 
the universities can create

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many, many different prices

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in a way that approaches
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
of financial aid,

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but the amount varies tremendously.

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

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

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While students
from very poor families

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

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That's meaning
that one price can be

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about 20 times higher
than the other.

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That's a lot of price discrimination.

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Price discrimination makes
a lot of sense for universities

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because their marginal costs are low

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while their fixed costs
are pretty high.

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If a professor is teaching
Economics 101 anyway,

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then the marginal cost of putting
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
a smaller amount in tuition

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is probably adding more
to profits than to costs.

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That helps the university
cover its fixed costs

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such as the salaries
and the buildings

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necessary to support
the operations of the university.

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So again, price discrimination
by the universities

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increases profits,

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but it also probably increases
their output as well.

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More students attend university
than otherwise would be the case.

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

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around a larger number
of customers.

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For these reasons,
price discrimination by universities

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probably increases social welfare.

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

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In the next talk we'll be looking

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at some quite common
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
of price discrimination.

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- [Announcer] If you want
to test yourself,

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click “Practice Questions.”

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

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♪ [music] ♪