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### Course: AP®︎/College Microeconomics>Unit 4

Lesson 3: Price discrimination

# Price discrimination

Explore an example of a wine producer who practices price discrimination by selling the same wine with different labels at different prices. This strategy allows the producer to capture more consumer surplus and increase their economic profit. The producer is a monopolistic competitor, as their wine is differentiated, and they have a monopoly in their specific wine market. Created by Sal Khan.

## Want to join the conversation?

• Does this type of thing - price discrimination - occur in the real world? If so, where?
(11 votes)
• It happens all the time: the price of adult tickets vs childrens' tickets at the movies; seniors' prices at various stores; airlines tickets - business class vs those last-minute deals...
(19 votes)
• What is the difference between First Degree Price Discrimination and Second Degree Price Discrimination? Define key distinguishable traits of each. Please.
(11 votes)
• Second Degree Price Discrimination is using volume discounts, in declining blocks, so that one price is charged for the first 100 units (for example) and a lower price is charged for the next 300 units, etc. Third degree price discrimination is charging different prices based on buyer characteristics, such as student or senior citizen discounts and separating or segmenting the market. First degree price discrimination can be thought of as a combination of second and third degree price discrimination. The discussion here on Wikipedia is on target: http://en.wikipedia.org/wiki/Price_discrimination
(8 votes)
• Why does the marginal revenue curve have twice the slope of the demand curve?
(7 votes)
• There's a video on this later in the playlist, but I'll put it here anyways for others who are confused:

We draw a linear demand curve on a P vs Q axes. The demand curve can be described as P=mQ+b where P is the price, m is the slope of the demand curve (negative), Q is the quantity, and b is the y-intercept (value of P when Q=0).
Now, total revenue = P*Q. Writing P in terms of Q, we have:

TR=(mQ+b)*Q=mQ^2+bQ.

Marginal revenue is defined as the instantaneous change in total revenue, i.e. MR is the derivative of TR with respect to Q. Taking the derivative of TR with respect to Q, we get:
d/dQ (TR)=2mQ+b.

The y-intercept of MR and the demand curve are the same (b), but the slope of the MR curve is 2m while the slope of the demand curve is m, therefore, the slope of the marginal revenue curve has twice the slope of the demand curve. Note that this only applies to monopolistic situations.
(4 votes)
• What is the reverse of first degree price discrimination?
Say, for example, I make the first three hundred units of wine as promised, but the make the rest at a lower ATC and sell them for the same price toting the same brand, bottle and prizes. What would you call that?
(4 votes)
• I am not sure if this somehow answers your question, but there exists the concept of "Fourth degree price discrimination", in which a company charges the same, but for a more expensive product.

For example, some restaurants may allow you to change the side fried potatos for vegetables for the same meal price. Then, the price is not changed, but the cost is, and therefore this is sometimes called "reverse of price discrimination".

Now, this is not precisely what you asked for, but it may be interesting as well :).
(9 votes)
• How can you view the MC curve as the supply curve? Since the supply curve is the average cost of production of the given quantity and the marginal cost is just the cost of one extra product?
(5 votes)
• Great Question! But the supply curve really is the marginal cost curve (assuming sufficient levels of competition).

Think of it this way. After already having sold 100 widgets, what is the lowest price the seller would be willing to charge for the 101st. The answer is (an infinitesimally small amount above, or more simply) the cost to produce the item.
If you imagine the decision from the moment of its making, it might make more sense.
(6 votes)
• Would an auction that sells multiple numbers of the same good be considered an example of perfect price discrimination?
(5 votes)
• Is price discrimination actually legal?
(3 votes)
• Yes, although there are laws on how greatly a company can price discriminate to protect the consumer. Price discrimination is as simple as offering more than one product to consumers.

Any company that offers different size upgrades McDonald's, Burger King etc is price discriminating. All it really means is that they are offering different products for different people to maximize how much you spend.

For a not so hungry person, they will get a small meal and pay less. and are happy to do so knowing that they can pay less and save more.

For a hungrier person, they will order a large meal and pay more, however they are also happy to do so, because they are willing to pay more for more food. They also realize that it is better value to order more and hence are happy to pay more.

McDonald's is super happy! Because instead of only being able to capture people with large appetites and deter those with small appetites or vice-versa they now have both consumers coming into their stores and paying for goods.

Virtually all companies price discriminate: Airlines, soft drinks, fast food, postage handling, Mobile phone companies and the list goes on. There are cases where price discrimination has been too extreme and deemed unlawful, but in general it's definitely legal :)
(5 votes)
• Hi. I would like to ask how can consumers actually fight against price discrimination. I had some friends who are treated with third degree price discrimination on some online game. The degree of price discrimination is very high. Hence, i would hope that consumers have an avenue to voice out this unfair of treatment. Thank you.
(3 votes)
• In general, the consumer's best way of avoiding price discrimination is to act like a consumer that is barely interested in or can barely afford the product. This would be based on how the company was performing its discrimination. Wine snobs could have avoided getting discriminated against by buying Sal's regular label wine from the grocery store instead of going to a wine store to pick up a premium label wine. Companies can get the tourist's prices for airline tickets by acting like a tourist and buying their airline tickets more than a couple weeks in advance.
(3 votes)
• What is three degree of price discrimination
(3 votes)
• First degree is as shown, where the price is based on how much the person buying the good is willing pay. The seller must know the maximum the buyer will pay.
Second degree is when the price changes depending on the quantity demanded. Firms may sell off packages of a product at a lower price, for example plane tickets when at the last minute.
Third degree is where the price changes for different segments of the market. For example, discounted cinema tickets for students. Whoever sits in a seat doesn't affect the cinema's costs, but people are charged different prices.
(3 votes)
• The ATC curve intersects the MC curve at its absolute minimum, and that's ok. But is it just a coincidence that it also intersects the Demand curve in the very same point?
(4 votes)
• Yes, it is just a coincidence that the demand curve intersects the minimum point on the ATC curve.
(1 vote)

## Video transcript

Narrator: Let's say that I am a producer of wine and in this axis, vertical axis, this is dollars per bottle, so 10, 20, 30, \$40 per bottle. On this axis right over here I will have quantity of bottles I produce per week. Let's say that this is 100, this is 200, 300 and then 400. This is quantity of bottles per week, per week and this is dollars per bottle. Let's think about the demand curve here. The demand curve for my type of wine, we're going to assume this is highly differentiated wine, the demand curve looks something like that. Now, I'm doing it as a straight line for simplicity. The demand curve looks like that. Since I said differentiated, this is not going to be perfect competition. I have a monopoly in my type of wine, so this isn't the market for wine generally, this is a market for my wine. My wine has won some taste tests, it has this unique flavor and whatever else, so you can view me as a monopolistic competitor. There's obviously competition from other wine labels, from other wine producers, but my wine is differentiated and I have a monopoly in my particular type of wine. We've done this multiple times, if I have a monopoly in my type of wine, we're talking about the market in my wine, then my marginal revenue curve, my marginal revenue curve will have twice the slope of this, so it will look something like that. It will actually keep going negative after that, so that is my marginal revenue curve. Then we can think about the cost side. The cost side of things, my marginal cost might look something like this. Marginal cost or you could even view that as a supply curve for my wine. Then we can also do average total cost. So the average total cost start off high, we have a fixed cost divided by a small quantity, but the marginal costs are lower than the average so the average keeps going down and down and down and down, then they're equal. Now each incremental unit is bring up the average in cost, so then the average total in cost might look something like that. Average total cost. We've seen this show multiple times. If in the near term, I do have a monopoly here, so I will just produce the quantity where my marginal revenue is equal to my marginal cost. Before that quantity, for every unit, I'm getting economic profit, economic profit, economic profit. If I produce more than that I'm not getting any economic profit anymore, so I'm going to produce this quantity which, I don't know, looks like about 160 units and I'm going to sell it ... I'm going to sell it for ... Oh, I'm going to be careful here. The price I'm going to be able to sell it, so this is the quantity that I'm going to be able to sell, the price that I'm going to sell it at, go up to the demand curve, that point of the demand curve and it looks like I'll be able to sell it for about, I don't know, \$33 a bottle. So, \$33 a bottle and if we want to think about economic profit, this is the average revenue per bottle, this is the average cost per bottle. So, this is the average economic profit per bottle and I multiply that times the total number of bottles and I'm going to get my economic profit. This area right over here is my total economic profit. We can think about how much are the consumers benefiting from it and how benefit are they getting excess of what they're paying for it and that would be this area right over here. That is the consumer surplus. (writing) Consumer, consumer surplus. Now, let's say I'm just not happy with this. I see that there's an opportunity here to get even more economic profit because after all we've been talking about this from the beginning. There are people here who are getting over \$40 of benefit from my wine, but I'm selling it to them for only \$33. Everything we've assumed so far is that we're selling ... all the consumers are buying something at the exact same price, but I'm a crafty wine producer and I say, well, let me call that in to question. Why can't I just put a different label on my exact same wine and sell it to these people for a different price and so I do that exact thing. I still produce this exact same quantity, I produce this exact same quantity, but the first hundred units of my quantity I put a different label on it. This label says 'Super Fancy Wine.' (writing) Super Fancy Premium, the best wine you ever drank. Super Fancy Premium Wine, it has all of the awards, all of the fancy people who like it. I put it in the best wine boutiques and the best restaurants, with that label, all the exact same stuff in the bottle and I sell that one at \$40 a bottle. So the first hundred units I sell at \$40 a bottle, so now my economic profit on those units ... remember, I'm producing 150, so my average total cost is down here. My average total cost is this line right over here. So, on those bottles I'm getting this much economic profit per bottle times these hundred units. I've now increased my economic profit. I've eaten into the consumer surplus. I've taken some of that for myself and turned it in to economic profit and then the other, I don't know, this looks like about 60 or 70 bottles, I just have with the traditional label and I maybe sell at the supermarket. (writing) Traditional, traditional label and I just sell it at the supermarket. I call it, just, Pretty Good Wine, just so in case someone who bought it at the fancy place doesn't see that the Pretty Good Wine is the exact same thing. What I've just done here is I've discriminated, I've discriminated amongst consumers depending on consumers willingness to pay, I've essentially charged them different prices and also, to some degree, based on where they shop and their gullibility, I am charging them two completely different prices. This right over here is called price discrimination. It's a way that a supplier can essentially take some of the consumer surplus for themselves, eat into some of that excess marginal benefit that they're essentially giving it to the consumer and turning it into economic profit.