The Social Welfare of Price Discrimination
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0:02 - 0:05♪ [music] ♪
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0:09 - 0:14- In our last video, we saw that price
discrimination is good for the monopolist. -
0:14 - 0:18It increases profits, but what about for
society as a whole, this price -
0:18 - 0:24discrimination increase social welfare?
That's the topic of today's talk. -
0:28 - 0:32It's complicated but here's a rule of
thumb, if price discrimination increases -
0:32 - 0:37output then it's very likely to be
beneficial to increase social welfare, if -
0:37 - 0:42output however does not increase then
welfare probably is reduced. Let's give -
0:42 - 0:46some intuition for when price
discrimination increases welfare. Think -
0:46 - 0:51about our previous example of the
pharmaceutical company GSK setting a high -
0:51 - 0:56drug price in Europe and a lower drug
price in Africa. Suppose that GSK were -
0:56 - 1:01forced to charge only one price. Do you
think it would charge closer to the -
1:01 - 1:07European price of $12.50 per pill or
closer to the African price of 50 cents -
1:07 - 1:14per pill? What's more likely to happen if
GSK is required to set only one price? If -
1:14 - 1:19they can't price discriminate, GSK very
likely will simply abandon the African -
1:19 - 1:24market where they weren't making that much
profit anyway and set a single world price -
1:24 - 1:29pretty close to the European level. People
sometimes think that if only everyone were -
1:30 - 1:35allowed to import pharmaceuticals to the
United States from Canada, Mexico or -
1:35 - 1:40Africa where they're cheaper, then we would
all enjoy lower prices. Probably not. -
1:40 - 1:45Smuggling or illegal re-emportation of
pharmaceuticals were to become more common -
1:45 - 1:50than pharmaceutical companies would stop
price discriminating and set higher prices -
1:50 - 1:56for everyone. Who would be made better off
by the resulting single price? Well, -
1:56 - 2:00Europeans are not better off because
they're still paying a high price under -
2:00 - 2:03the single price rule, but Africans are
going to be worse off. -
2:03 - 2:07Because they will no longer have the
option of buying important drugs at the -
2:07 - 2:12lower prices. In this case, price
discrimination is beneficial because it -
2:12 - 2:17increases output. It gives some Africans
the chance to buy at a lower price when -
2:17 - 2:21they otherwise would not have had that
chance under a no price discrimination -
2:21 - 2:27rule. For industries with high fixed costs
price discrimination has another benefit, -
2:27 - 2:31the extra profits generated by price
discrimination mean that it's more -
2:32 - 2:36profitable for the company to engage in
research and development to produce more -
2:36 - 2:42new drugs for instance. For example the
extra profits from selling in Africa mean -
2:42 - 2:46that research and development is more
profitable, and that benefits Europeans -
2:46 - 2:51too. When it comes to new drugs, you might
say that misery loves company. That is the -
2:51 - 2:55larger the market for a potential drug the
more research and development will be -
2:56 - 3:01applied. Price discrimination similarly
means airlines can offer more flights to -
3:01 - 3:06more places at better times, and that also
helps business people. Even though they're -
3:06 - 3:10paying the higher prices, they have a
better chance at being able to get there -
3:10 - 3:15at a good time in the first place. When it
comes to software, lower price is for the -
3:15 - 3:21students also is going to help support
software R and D. If the students wouldn't -
3:21 - 3:25buy the software at all at the higher
price, well, then the price discrimination -
3:26 - 3:30is a net benefit to pretty much everyone.
More generally price discrimination can -
3:31 - 3:36help spread the fixed costs of research
and development over a larger population -
3:36 - 3:41and that means more innovation which is to
virtually everyone's benefit. The ultimate -
3:41 - 3:45form of price discrimination is when each
person is charged his or her maximum -
3:46 - 3:51willingness to pay. Economist call this
'perfect price discrimination,' under -
3:51 - 3:57perfect price discrimination consumers end
up with zero consumers surplus. All of the -
3:57 - 4:01gains from trade go to the monopolist, but
the efficient quantity is produced. -
4:01 - 4:06There's no dead weight loss. Let's look at
this with a diagram. Think of the demand -
4:06 - 4:11curve as showing the maximum willingness
to pay by different individuals to buy a -
4:11 - 4:17single unit of this good. Here for example
is Alex's willingness to pay, here's -
4:17 - 4:22Tyler's willingness to pay, Robin's and on
all the way down to Brian's willingness to -
4:22 - 4:28pay for the good. If the monopolist could
charge each and every consumer his or her -
4:28 - 4:33maximum willingness to pay, the monopolist
would walk down the demand curve producing -
4:33 - 4:39each unit such that the willingness to pay
just exceeded the marginal cost. In other -
4:39 - 4:44words the monopolist would produce every
unit up until the efficient quantity of -
4:44 - 4:49output, the same quantity as would be
produced by a competitive industry. The -
4:49 - 4:53difference being that in the competitive
industry the gains would go to the -
4:53 - 4:58consumers. In the case of perfect price
discrimination, all the gains go to the -
4:58 - 5:02monopolist. This kind of price
discrimination requires that the -
5:02 - 5:07monopolist have a lot of information about
each consumer. Are there examples of this -
5:07 - 5:13in practice? In fact there are some, and
you maybe very familiar with one of them. -
5:13 - 5:17Universities are fabulous price
discriminators. They're even better than -
5:17 - 5:22airlines, especially because few people
realize what is actually going on. -
5:22 - 5:27Universities give many students financial
aid, which is another way of saying that -
5:27 - 5:31they charge some of their students more
than others. Financial aid is a way of -
5:32 - 5:36doing well while doing good because it's a
form of price discrimination. It increases -
5:36 - 5:42profits for universities. Moreover to get
the aid, students and their parents must -
5:42 - 5:46give the university an incredible amount
to financial information, including their -
5:46 - 5:52tax forms, their W2's, information about
their bank accounts, the home they own and -
5:52 - 5:57so on. All of this information means the
universities can create many many -
5:57 - 6:02different prices in a way that approaches
perfect price discrimination. -
6:02 - 6:06At William's College for instance, half
the students pay full fare. Which is about -
6:07 - 6:12$32,000 a year, the other half gets some
form of financial aid but the amount -
6:12 - 6:18varies tremendously. Students whose
parents have incomes of about $91,000 a -
6:18 - 6:24year or higher, they pay an average
intuition of about $22,000 a year. While -
6:24 - 6:30students from very poor families may pay
as little as $1,600 a year. That's -
6:30 - 6:35meaning that one price can be about 20
times higher than the other, that's a lot -
6:35 - 6:39of price discrimination. Price
discrimination makes a lot of sense for -
6:39 - 6:43universities because their marginal costs
are low while their fixed costs are pretty -
6:43 - 6:48high. If a professor is teaching
economics 101 anyway, then the marginal -
6:48 - 6:54cost of putting an extra student in the
classroom is pretty close to zero. Even a -
6:54 - 6:59student who is paying a smaller amount in
tuition is probably adding more to profits -
6:59 - 7:05than to costs. That helps the university
cover its fixed costs such as the salaries -
7:05 - 7:10and the buildings necessary to support the
operations of the university. So again -
7:10 - 7:15price discrimination by the universities
increases profits but it also probably -
7:15 - 7:21increases their output as well. More
students attend university then otherwise -
7:21 - 7:25would be the case. And again, price
discrimination also helps to spread the -
7:25 - 7:31fixed costs around a larger number of
customers. For these reasons, price -
7:31 - 7:36discrimination by universities probably
increase the social welfare. That's it for -
7:36 - 7:40the more obvious forms of price
discrimination. In the next talk we'll be -
7:40 - 7:44looking at the some quite common pricing
strategies, such as tying and bundling, -
7:44 - 7:49which also can be understood as more
subtle forms of price discrimination. -
7:51 - 7:55- If you want to test yourself, click
practice questions. -
7:55 - 7:58Or, if you're ready to move on,
just click 'next video.' -
7:59 - 8:02♪ [music] ♪
- Title:
- The Social Welfare of Price Discrimination
- Description:
-
Now that we’ve learned a little about price discrimination, we can begin to think about whether or not price discrimination is bad for society. How does price discrimination affect output, and what is this effect on social welfare? If price discrimination increases output, it is likely beneficial for society. If output isn’t increased, social welfare is reduced. What are some examples of perfect price discrimination? Universities practice perfect price discrimination all the time. Students pay different amounts for their education based on many different factors surrounding each student’s ability to pay. This practice increases profits and also increases the number of students able to attend college. For this reason, price discrimination by universities likely increases social welfare.
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- Video Language:
- English
- Team:
- Marginal Revolution University
- Project:
- Micro
- Duration:
- 08:04
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