Arnold Kling  

The Virtues of Price Discrimination

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Jeff Ely writes,


the winners and losers from an auction system aren't who you think. Auctions don't favor the deep-pocketed compared to the small guys. Exactly the opposite. The marginal consumer is priced out of the market when a seller eschews an auction because then he must keep prices high. When a seller switches to an auction he lowers his reserve price and now the marginal consumer has a chance to buy at those low prices.

Pointer from Tyler Cowen.

I believe that this is a special case of a general theorem about monopoly, which is that price discrimination gets you closer to the socially optimal quantity of output. Note, however, that the distributional effects may or may not be what you would like.

Remember what I tell my students: Price Discrimination Explains Everything.


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CATEGORIES: Microeconomics



COMMENTS (4 to date)
Steven writes:

"I believe that this is a special case of a general theorem about monopoly..."

You're remembering the theorems incorrectly, in a pretty serious way. Firms with market power produce too little output, so moving toward the socially optimal output requires total quantity to increase. Price discrimination has ambiguous effects on total quantity. Also, conditional on the total quantity, price discrimination lowers total welfare (because it diverts output from high-value users to low-value users). With enough simplifying assumptions (Robinson 1933), total welfare increases if and only if total output increases (i.e., the value of increased output always more offsets the reduction from mis-allocation). In more general setups (Schmalensee 1981) an increase in total output is necessary but not sufficient for total welfare to increase.

With perfect price discrimination your intuition is correct, however. Total output rises to the socially optimal level, and the firm captures the entire social surplus.

david writes:

"Total output rises to the socially optimal level, and the firm captures the entire social surplus." - observe that this favors the firm's shareholders, i.e., we're back to big guy vs. little guy. Big guys own disproportionate shares of capital, even.

I suspect that in real life effects of a given marginal change are probably going to be ambiguous.

Ghost of Christmas Past writes:

American undergraduate colleges and universities practice perfect price discrimination (with help from the universal financial aid application form, submitted under penalty of perjury with copies of student's and parents' tax returns, etc. attached)...

Dave Tufte writes:

Tufte's Version: monopoly power explains everything, including price discrimination and mark-ups.

The thing that most people don't realize is that they only observe monopolies that earn non-negative economic profits.

What upsets people about the world is that other poeple have monopolies that can price discriminate and make positive profits, while their own monopolies (like my monopoly on my own hi hop performances) freely exit the market.

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