Welcome to Week nine of The Power of Markets course here from the Simon Business School at the University of Rochester. What we're going to do this week is finish up the application, certain applications of price discrimination. From the last couple of sections of Chapter 12 for those of you that are following In the text, cover much of chapter 13, which deals with cases between perfect competition in pure monopoly. Where you have a small number of suppliers, or a larger number of suppliers selling differentiated products that have some ability to affect the price that gets charged for their product. And then we'll turn to the beginning sections of chapter 14, which deal with Game Theory. And what Game Theory does is allow us to better analyze interactions between firms in oligopolistic settings. And oligopoly is one of the settings that we'll cover in Chapter 13 in, in this week in the videos. Let's first though finish up in this session and the next one Price Discrimination. Let's look at one other case of Intertemporal Price Discrimination. Which is a type of third degree price discrimination, where the price varies by time, day of use. That takes into account certain people who are more eager to buy the product. Others can wait to make the purchase. We see this with purchases of printed material. Some people would like the book earlier, and are willing to pay more for the hard copy form. Others are willing to wait for the paperback version and pay a lower price. Sometimes you see this when you try to renew a magazine subscription. I noticed this a few years ago with Psychology Today. I was trying to kill off my subscription to the magazine. The longer I waited, the more mailings I kept getting. And I noticed that as I held out longer, the price for the renewal started to come down. Psychology Today was sensitive to the dif they wanted to get me to renew since I was holding out so long. They'd have to lower the price to keep me. You see this sometimes with hardware that initially a higher price for a new version of the iPhone. And then the price comes down over time. Sometimes that's due to competition, but sometimes it's due to Intertemporal Price Discrimination. Let's take a look at how Intertemporal Price Discrimination works. And let's say we have two types of customers and, and you see this also in in the case of movie theaters with video programming, where they're called windows. The traditional run would be for a movie to appear in some premiere theaters. Especially in places like New York City and Los Angeles in the United States, and then more general distribution to theaters around the country. And then internationally. And then the next window would be home video where people would pay not so much as they would at a cinema but still to rent on Netflix or historically, through Blockbuster. Through a form that way. Or, or paying through their cable TV provider. Would be the next window and then broadcast TV, and then the second cable run, and then syndication. So these different windows were designed to take into account people's different sensitivity to price for a given unit of video programming. Let's say we have two classes of customers. One that's eager to purchase the product, and that they're associated with the demand curve, DE, and the associated marginal revenue curve, MRE. And then those customers that are willing to wait are associated with the demand curve, DW. And its affiliated marginal revenue curve, MRW. For the eager customers if the marginal costs are the same for producing the product, either for eager or, or, more patient consumers for the eager customers, the price gets set at a higher level. So where MR equals MC, looking at the MR for the eager customers. And then shooting that quantity up to the height of the demand curve for eager customers. For those that are willing to wait. Quantity QW, we shoot that up to the demand curve for those that are willing to wait. So a lower price gets paid. You see this too with airline markets where leisure travelers typically get charged a lower fair, and, but the way airlines segment those from business travelers is require the leisure travelers to purchase the tickets further in advance to stay over a Saturday night and sometimes, there are ways to arbitrage that opportunity. Remember from the last week, one of the conditions of price discrimination was the ability to prevent arbitrage. And that ability customers can make inroads into airlines attempts to discriminate between leisure and business travelers. Let me give you an example. A few years ago, I was living in Los Angeles, and in the month of April I'll split it off into different weeks. And days of the week, starting with Sunday, Monday, Tuesday and Wednesday. Thursday, Friday, Saturday. And I had to travel between LA and Chicago to give a paper on, two consecutive Wednesdays. And had I the bought just flying from LA returning either that night or the next day from Chicago. So the business fare was around $800 round trip. But the way to arbitrage that and this still exists, because you can also buy more leisure class tickets that require a Saturday night stay is the first ticket I bought. And let's say I was initially going to fly there Wednesday, return on Thursday, and then the next week, had to be there again on Wednesday and Thursday. The first ticket I bought originated out of LA going to Chicago on that third week of April. And the return portion came back outta Chicago the following week for my second trip there. So it included a Saturday night stay. And with the Super Saver fare, I was able to pay only $400 for that round trip. And then the second ticket I bought originated out of Chicago. On Thursday went to LA, so I took half of my first trip. And then originated out of LA going back to Chicago for the second trip I needed to take to Chicago. So I ended up saving for the schools that invited me to give talks a total of $400. Now in the old days even if you had to take one trip, what people would do is still find ways to arbitrage this attempt at price discrimination by airlines. But create, so, if you had to go to Chicago only one week, buy two per, supersaver tickets that were the equivalent of the price of one business class trip and then resell the tickets in cases like the LA Times. The the classifieds used to have ads from people saying, I've got one airline ticket round trip Chicago to LA or LA to Chicago. If in case you'd want to buy it. Nowadays you can't do that because of TSA regulations, so they're requiring photos. Security's not the only reason that airlines have become more conscious of who's traveling. It's also to try to crack down on arbitrage near travel. Now, a form of companies charging different prices that isn't price discrimination is called peak-load pricing. And this is where prices depend on the cost of providing the service. Again, an important thing to remember. Price discrimination only involves cases where companies are trying to charge different prices based on consumers' different valuations for the same product. In cases where the costs differ different prices. Being charged associated with different costs is not price discrimination. But a case of the latter where it crops up is termed Peak-Load Pricing. And let's say in the case of phone service. It's more expensive to call nowadays on Mother's Day or on certain holidays than other times of the year. Or it's more expensive to call in general during the week, during business hours than it is on the weekends. Sometimes those types of differential prices reflect differences in the cost of providing the service. And let's say we have a case where the short run marginal cost curve is upward sloping, and demand at certain periods is higher, D1, than at others. If the company charges a uniform price, there are two costs associated with that uniform price. First, their deadweight loss is produced, because in the case of the lower demand, the price is set above marginal cost. And the quantity is below the efficient level of output in the lower demand periods. So you'd want to set a price. All the way out to where each unit was produced that was valued more than marginal costs. So out to Q2 prime. And in the higher demand periods the price is set too low. So demand, quantum demand ends up being Q1 where the short run marginal cost is above the value consumers place on the product in these higher demand periods. You'd want to actually reduce output. Reduce the quantity demanded, and reduce it to the point where at Q1 prime, each unit that's produced is valued, at least as highly as the social marginal, as the short run marginal cost curve. So by charging too low a price you've output is your consumption is higher than the official level of output in the higher demand periods. So the first cost of uniform pricing involves dead weight losses because you aren't paying attention in each period what the short run marginal cost is, relative to demand. And then there's also a long run cost, if you're installing capacity to handle a certain number of phone calls. That capacity also costs money, and if you're charging a uniform price. You'll end up over building capacity. Q1 as opposed to Q1 prime. So you'll over-invest in this capacity. So peak-load pricing, what it involves is saying, look, we want to pay attention to marginal costs in each period. And in low-demand periods we want to charge P2 out to where demand is at least as high in height as social, as short run marginal cost. And in the high peak, high demand periods we're charging a price P1 where every unit that's produced in the high demand periods is valued at least as much as the short run marginal cost. Couple examples of peak-load pricing Color Corporation out of Wisconsin for example a few years ago, noticed that the price for electricity in running their plants was twice as high during the day as at night. And they actually shifted production to the evening hours. They had to pay $50,000 more to employees to work evening and overnight hours, but they ended up saving $450,000 a month in electricity costs. Where else you'll see peak-load pricing is in certain toll roads that are, are being constructed. In the United States and, and elsewhere around the world, for example, in Southern California. There's a stretch of road, a toll road 91, where the price varies depending on the time at which you use the road. It can be as high as $4. For that stretch, or as low as $.40 to travel, depending on if you're traveling when that capacity is stretched due to more traffic and there's greater congestion. So if there're greater costs associated and you charge different prices, it's not price discrimination, but we do see those differential prices that are cost-based and that we term Peak-Load Pricing.
