The Social Welfare of Price Discrimination
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0:02 - 0:05♪ [music] ♪
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0:09 - 0:11- [Tyler] In our last video,
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0:11 - 0:14we saw that price discrimination
is good for the monopolist. -
0:14 - 0:15It increases profits,
-
0:15 - 0:18but what about
for society as a whole, -
0:18 - 0:24does price discrimination
increase social welfare? -
0:24 - 0:27That's the topic of today's talk.
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0:28 - 0:29It's complicated, but here's
a rule of thumb -- -
0:29 - 0:32if price discrimination
increases output -
0:32 - 0:34then it's very likely
to be beneficial, -
0:34 - 0:37to increase social welfare.
-
0:37 - 0:39If output, however,
does not increase -
0:39 - 0:42then welfare probably is reduced.
-
0:42 - 0:43Let's give some intuition
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0:43 - 0:46for when price discrimination
increases welfare. -
0:46 - 0:48Think about our previous example
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0:48 - 0:51of the pharmaceutical company GSK
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0:51 - 0:53setting a high drug price in Europe
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0:53 - 0:56and a lower drug price in Africa.
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0:56 - 0:58Suppose that GSK were forced
to charge only one price. -
0:58 - 1:01Do you think it would charge
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1:01 - 1:04closer to the European price
of $12.50 per pill -
1:04 - 1:07or closer to the African price
of 50 cents per pill? -
1:07 - 1:11What's more likely to happen
-
1:11 - 1:14if GSK is required
to set only one price? -
1:14 - 1:16If they can't price discriminate,
-
1:16 - 1:19GSK very likely will simply abandon
the African market -
1:19 - 1:21where they weren't making
that much profit anyway -
1:21 - 1:24and set a single world price
-
1:24 - 1:27pretty close to the European level.
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1:27 - 1:30People sometimes think that
if only everyone were allowed -
1:30 - 1:35to import pharmaceuticals
to the United States from Canada, -
1:35 - 1:37Mexico or Africa
where they're cheaper, -
1:37 - 1:38then we would all enjoy
lower prices. -
1:38 - 1:40Probably not.
-
1:40 - 1:42Smuggling or illegal re-importation
of pharmaceuticals -
1:42 - 1:45were to become more common,
-
1:45 - 1:50then pharmaceutical companies
would stop price discriminating -
1:50 - 1:53and set higher prices for everyone.
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1:53 - 1:56Who would be made better off
by the resulting single price? -
1:56 - 1:57Well, Europeans are not better off
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1:57 - 2:00because they're still paying
a high price -
2:00 - 2:01under the single price rule,
-
2:01 - 2:03but Africans are going
to be worse off, -
2:03 - 2:04because they will no longer
have the option -
2:04 - 2:07of buying important drugs
at the lower prices. -
2:07 - 2:12In this case,
price discrimination is beneficial -
2:12 - 2:14because it increases output.
-
2:14 - 2:17It gives some Africans
the chance to buy at a lower price -
2:17 - 2:21when they otherwise would not
have had that chance -
2:21 - 2:24under a no price discrimination rule.
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2:24 - 2:25For industries
with high fixed costs, -
2:25 - 2:27price discrimination
has another benefit - -
2:27 - 2:31the extra profits generated
by price discrimination mean -
2:32 - 2:33that it's more profitable
for the company -
2:33 - 2:36to engage in research
and development -
2:36 - 2:39to produce more new drugs
for instance. -
2:39 - 2:42For example, the extra profits
from selling in Africa -
2:42 - 2:46mean that research and development
is more profitable, -
2:46 - 2:48and that benefits Europeans too.
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2:48 - 2:49When it comes to new drugs,
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2:49 - 2:51you might say that misery
loves company. -
2:51 - 2:53That is, the larger the market
for a potential drug, -
2:53 - 2:56the more research
and development will be applied. -
2:56 - 3:01Price discrimination similarly
means airlines can offer -
3:01 - 3:03more flights to more places
at better times, -
3:03 - 3:04and that also helps business people.
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3:04 - 3:06Even though they're paying
the higher prices, -
3:06 - 3:10they have a better chance
at being able to get there -
3:10 - 3:15at a good time in the first place.
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3:15 - 3:18When it comes to software,
lower prices for the students -
3:18 - 3:21also is going to help
support software R&D. -
3:21 - 3:23If the students wouldn't buy
the software at all -
3:23 - 3:26at the higher price,
well then the price discrimination -
3:26 - 3:28is a net benefit
to pretty much everyone. -
3:28 - 3:31More generally, price discrimination
can help spread the fixed costs -
3:31 - 3:36of research and development
over a larger population, -
3:36 - 3:38and that means more innovation
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3:38 - 3:41which is to virtually
everyone's benefit. -
3:41 - 3:43The ultimate form
of price discrimination -
3:43 - 3:46is when each person is charged
-
3:46 - 3:48his or her maximum
willingness to pay. -
3:48 - 3:51Economists call this
“perfect price discrimination.” -
3:51 - 3:54Under perfect price discrimination,
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3:54 - 3:57consumers end up
with zero consumers surplus. -
3:57 - 3:58All of the gains from trade
go to the monopolist, -
3:58 - 4:01but the efficient quantity
is produced. -
4:01 - 4:03There's no deadweight loss.
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4:03 - 4:06Let's look at this with a diagram.
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4:06 - 4:08Think of the demand curve as showing
the maximum willingness to pay -
4:08 - 4:11by different individuals to buy
a single unit of this good. -
4:11 - 4:17Here, for example,
is Alex's willingness to pay. -
4:17 - 4:20Here's Tyler's willingness to pay,
Robin's, and on, -
4:20 - 4:22all the way down to Brian's
willingness to pay for the good. -
4:22 - 4:28If the monopolist could charge
each and every consumer -
4:28 - 4:30his or her maximum
willingness to pay, -
4:30 - 4:33the monopolist would walk
down the demand curve -
4:33 - 4:36producing each unit such
that the willingness to pay -
4:36 - 4:39just exceeded the marginal cost.
-
4:39 - 4:41In other words, the monopolist
would produce every unit -
4:41 - 4:44up until the efficient
quantity of output, -
4:44 - 4:49the same quantity as would be
produced by a competitive industry. -
4:49 - 4:53The difference being that
in the competitive industry, -
4:53 - 4:55the gains would go
to the consumers. -
4:55 - 4:58In the case of
perfect price discrimination, -
4:58 - 4:59all the gains go to the monopolist.
-
4:59 - 5:02This kind of price discrimination
requires that the monopolist have -
5:02 - 5:07a lot of information
about each consumer. -
5:07 - 5:10Are there examples
of this in practice? -
5:10 - 5:11In fact there are some,
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5:11 - 5:13and you may be very familiar
with one of them. -
5:13 - 5:17Universities are fabulous
price discriminators. -
5:17 - 5:19They're even better than the airlines,
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5:19 - 5:22especially because few people
realize what is actually going on. -
5:22 - 5:24Universities give many students
financial aid, -
5:24 - 5:27which is another way
of saying that they charge -
5:27 - 5:31some of their students
more than others. -
5:32 - 5:33Financial aid is a way
of doing well while doing good -
5:33 - 5:36because it's a form
of price discrimination. -
5:36 - 5:39It increases profits
for universities. -
5:39 - 5:42Moreover, to get the aid,
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5:42 - 5:43students and their parents
must give the university -
5:43 - 5:46an incredible amount
of financial information, -
5:46 - 5:49including their tax forms,
their W2's, -
5:49 - 5:52information
about their bank accounts, -
5:52 - 5:54the home they own and so on.
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5:54 - 5:57All of this information means
the universities can create -
5:57 - 5:59many, many different prices
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5:59 - 6:02in a way that approaches
perfect price discrimination. -
6:02 - 6:04At Williams College for instance,
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6:04 - 6:07half the students pay full fare,
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6:07 - 6:09which is about $32,000 a year.
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6:09 - 6:12The other half gets some form
of financial aid, -
6:12 - 6:15but the amount varies tremendously.
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6:15 - 6:18Students whose parents have incomes
of about $91,000 a year or higher, -
6:18 - 6:24they pay an average in tuition
of about $22,000 a year. -
6:24 - 6:27While students
from very poor families -
6:27 - 6:30may pay as little as $1,600 a year.
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6:30 - 6:32That's meaning
that one price can be -
6:32 - 6:35about 20 times higher
than the other. -
6:35 - 6:36That's a lot of price discrimination.
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6:36 - 6:39Price discrimination makes
a lot of sense for universities -
6:39 - 6:43because their marginal costs are low
-
6:43 - 6:45while their fixed costs
are pretty high. -
6:45 - 6:48If a professor is teaching
Economics 101 anyway, -
6:48 - 6:54then the marginal cost of putting
an extra student in the classroom -
6:54 - 6:56is pretty close to zero.
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6:56 - 6:57Even a student who is paying
a smaller amount in tuition -
6:57 - 6:59is probably adding more
to profits than to costs. -
6:59 - 7:05That helps the university
cover its fixed costs -
7:05 - 7:07such as the salaries
and the buildings -
7:07 - 7:10necessary to support
the operations of the university. -
7:10 - 7:12So again, price discrimination
by the universities -
7:12 - 7:13increases profits,
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7:13 - 7:15but it also probably increases
their output as well. -
7:15 - 7:21More students attend university
than otherwise would be the case. -
7:21 - 7:25And again, price discrimination
also helps to spread the fixed costs -
7:25 - 7:31around a larger number
of customers. -
7:31 - 7:36For these reasons,
price discrimination by universities -
7:36 - 7:37probably increases social welfare.
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7:37 - 7:40That's it for the more obvious
forms of price discrimination. -
7:40 - 7:41In the next talk we'll be looking at
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7:41 - 7:43some quite common
pricing strategies, -
7:43 - 7:44such as tying and bundling,
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7:44 - 7:48which also can be understood
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7:48 - 7:51as more subtle forms
of price discrimination. -
7:51 - 7:52- [Announcer] If you want
to test yourself, -
7:52 - 7:55click “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:
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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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