Third-degree Price Discrimination Research Articles

Behavior-based algorithmic pricing

This article studies the impact of algorithmic pricing on market competition when firms collect data to charge personalized prices to their past customers. Pricing algorithms offer to each firm a rich set of pricing strategies combining first and third-degree price discrimination: they can choose for each of their past customers whether to charge them personalized or homogeneous prices. The optimal targeting strategy of each firm consists in charging personalized prices to past customers with the highest willingness to pay and a homogeneous price to the remaining consumers, including past customers with a low valuation on whom a firm has information. This targeting strategy maximizes rent extraction while softening competition between firms compared to classical models where firms target all past customers. In turn, price-undercutting and poaching practices are not sustainable with behavior-based algorithmic pricing, resulting in greater industry profits.

On the continuity of outcomes in a monopoly market

A monopolist with a constant marginal cost faces an arbitrary nondecreasing and upper-semicontinuous demand function on R+ that takes a value in {0,1} outside of a fixed compact interval. This paper derives topological properties of outcomes induced by this monopolist’s optimal pricing problem. Specifically, the monopolist’s optimal profit is continuous in the marginal cost and the demand (under the weak-* topology); the optimal price and output correspondences are upper-hemicontinuous in the marginal cost and the demand; and the consumer surplus is upper (lower)-semicontinuous when the monopolist charges the lowest (highest) optimal price. These results further imply similar topological properties of outcomes in settings that feature either second-degree price discrimination or third-degree price discrimination.

Serum: differential pricing of the Covid-19 vaccine

Learning outcomes The learning outcomes of this study are as follows: 1. the benefits of differential pricing over uniform pricing; 2. the differences between second- and third-degree price discrimination; 3. the rationale for charging different prices for segments having different willingness to pay; and 4. how different prices for the same product can lead to perceptions of unfairness and how companies might manage such an issue. Case overview/synopsis This case outlines the decisions that Adar Poonawalla, the CEO of Serum Institute of India (Serum), had to make in late April 2021 concerning its pricing for the COVID-19 (Covid) vaccine. Serum was the world’s largest manufacturer of vaccines, and its Covishield vaccine had received regulatory approval, but faced an unusual challenge and opportunity. In most countries, governments had procured Covid vaccines from manufacturers and then delivered the vaccines to consumers free of cost. But in India, there was a three-tier pricing system. While the Government of India had committed to free vaccines in government-run public hospitals, it also allowed vaccine makers to directly sell vaccines to state governments, as well as private hospitals, who were at liberty to charge consumers for the vaccines. This created an interesting pricing dilemma for Serum: as different customers had different willingness to pay, should Serum use differential pricing? Would such a tiered pricing system be considered fair? How many different price points should Serum maintain? By exploring these and related decisions that Poonawalla had to make, the case is intended to teach price discrimination. Complexity academic level The case is intended for graduate-level courses in marketing, pricing and economics. This case illustrates the principles of differential pricing/price discrimination. More specifically, it highlights pricing strategies motivated by second- and third-degree price discrimination in an emerging market’s health-care context. From the information in the case, the student can learn to apply the concepts of second- and third-degree price discrimination in marketing. After working through the case and assignment questions, instructors will be able to help students understand the following concepts: Teaching objective 1: the benefits of differential pricing over uniform pricing. Teaching objective 2: the differences between second- and third-degree price discrimination. Teaching objective 3: the rationale for charging different prices for segments having different willingness to pay. Teaching objective 4: how different prices for the same product can lead to perceptions of unfairness and how companies might manage such an issue. Supplementary material Teaching notes are available for educators only. Subject code CSS 8: Marketing

Third-Degree Price Discrimination in Two-Sided Markets

Third-Degree Price Discrimination in Two-Sided Markets

Third-Degree Price Discrimination in Two-sided Markets

Third-Degree Price Discrimination in Two-sided Markets

The Limits of Multiproduct Price Discrimination

We consider a multiproduct seller who has access to information about consumer preferences that he can use for second- and third-degree price discrimination. We characterize markets for which such information can lead to the efficient allocation with consumers obtaining the entire surplus gain relative to the profit-maximizing allocation without the additional information. This benchmark is achievable for all markets with a given set of consumer types if and only if it is optimal for the seller to offer only the best product in each market. Analogous results characterize when the “surplus triangle” of Bergemann, Brooks, and Morris (2015) is achievable. (JEL D11, D21, D42, D83)

A sufficient statistics approach for welfare analysis of oligopolistic third‐degree price discrimination

This paper proposes a sufficient statistics approach to studying the welfare effects of third-degree price discrimination in differentiated oligopoly. Specifically, our sufficient conditions for price discrimination to increase or decrease social welfare simply entail a cross-market comparison of multiplications of such sufficient statistics as pass-through, conduct, and profit margin that are functions of first-order and second-order elasticities of the firm’s demand. Notably, these results are derived under a general class of market demand, and can be readily extended to accommodate heterogeneous firms. These features suggest that our approach has potential for conducting welfare analysis without a full specification of an oligopoly model.

Harmonic price targeting

This paper studies third-degree price discrimination in a classical model of price competition with differentiated products. Firms charge different prices to different consumers, based on their estimate of their price sensitivity. If the market is fully covered and information is symmetric, more accurate information has a pure redistributive effect, leading to higher profits but lower consumer welfare. If the market is not covered, information always benefit firms but the welfare effects are ambiguous. If information is asymmetric, firms benefit from more information, but less so than in the symmetric case, and total welfare depends on the extent of this asymmetry. I conclude that firms have strong incentives to share information about consumer tastes.

Impact of Third-Degree Price Discrimination on Welfare under the Asymmetric Price Game

Whether third-degree price discrimination improves or damages social welfare has always been a hot topic for scholars of economics. At present, research studies on the impact of third-degree price discrimination on welfare have not been carried out under asymmetric price competition. To this end, we studied this problem. In the research process, we divided consumers into two market segments by setting different travel costs based on the Hotelling model; at the same time, we considered three scenarios in which both firms engage in uniform pricing, both engage in price discrimination, and price discrimination vs. uniform pricing, and some intriguing findings and conclusions that differ from the previous studies were obtained through game analysis: (1) compared with two symmetric price games, the total output effect of each firm is unchanged, but the total social welfare is reduced, and as the size of the strong market increases, the reduction effect of total social welfare increases first and then decreases; (2) from local social welfare analysis, although the output of the firm adopting price discrimination remains unchanged, it can produce more producer surplus, consumer surplus and social welfare third-degree; (3) while the firm that uses uniform pricing is at a disadvantage in competition, the local social welfare created by it is decreased, and the reduction effect of social welfare will increase first and then decrease as the increase of the size of the strong market occurs. These conclusions reveal in an oligopoly market why enterprises always choose price discrimination and the government acquiesces in the existence of price discrimination.

How do prosperity and aspiration underlie leisure tourism expenditure patterns?

This research advances the current knowledge of tourism expenditure by adapting a new analytical approach to understand expenditure differentials along their conditional distributions, based on multiple segmentation criteria. Using data from survey and secondary sources, we approximate tourists’ required utilities via prosperity at their countries of residence, a macro-level criterion, and individual-travel aspirations, a micro-level criterion. Subsequently, expenditure differentials between more and less prosperous/aspired tourists are decomposed into two components. First, group differences in expenditure covariates that represent tourists’ relative consumption behaviors and, second, differences in the estimated returns to those covariates, measuring potential third-degree price discrimination. Our results guide policy makers in the tourism industry to develop pricing strategies capable of generating mark-ups within all viable segmentations.

Gender and beauty price discrimination in produce markets

We design a field experiment to test for price discrimination at seemingly highly competitive Israeli produce markets. We trained 90 buyers and sent them to produce markets across Israel. After verifying a product's posted price, they asked for a discount on a one-kilogram or one-unit purchase. Predominantly male vendors employ third-degree price discrimination: women are offered larger and more frequent discounts than men, and the more attractive the female buyer, the larger and more frequent the discount offered. Male buyers do not benefit from this beauty discount. No other buyer characteristic is a significant predictor of the likelihood or size of a discount. To understand our findings, we provide a more nuanced view of these markets that includes search costs and considerable vendor price-setting discretion.

Teaching Third-Degree Price Discrimination by a Monopolist With Linear Demands

Teaching Third-Degree Price Discrimination by a Monopolist With Linear Demands

Third-degree price discrimination versus uniform pricing

We compare the profit of the optimal third-degree price discrimination policy against a uniform pricing policy. A uniform pricing policy offers the same price to all segments of the market. Our main result establishes that for a broad class of third-degree price discrimination problems with concave profit functions (in the price space) and common support, a uniform price is guaranteed to achieve one half of the optimal monopoly profits. This profit bound holds for any number of segments and prices that the seller might use under third-degree price discrimination. We establish that these conditions are tight and that weakening either common support or concavity can lead to arbitrarily poor profit comparisons even for regular or monotone hazard rate distributions.

Pricing the Pharmaceuticals when the Ability to Pay Differs

A non-trivial fraction of people cannot afford to buy pharmaceutical products at unregulated market prices. This paper analyses the public insurance of a patent-protected pharmaceutical product in terms of price controls and socially optimal third-degree price discrimination. First, the paper characterizes the Ramsey pricing rule in the case where the producer price has to cover the R&D costs of the firm and patients’ pharmaceutical expenditures are not covered by health insurance. Subsequently, conditions for a welfare increasing departure from the Ramsey pricing rule are stated in terms of price regulation and health insurance coverage. Unlike the earlier views expressed, the increased consumption of the pharmaceutical is shown to be welfare increasing. In the spirit of the Rawlsian view, a criterion for vertical equity is examined as an optimal means-tested health insurance. In this scheme, the regulator chooses a higher insurance coverage for individuals whose income is below an endogenously determined income threshold. The means-tested insurance scheme improves
 social welfare but also yields very equal market outcomes.

Monopolistic third-degree price discrimination, welfare, and vertical market structure

Monopolistic third-degree price discrimination, welfare, and vertical market structure

Measuring the effects of tourists’ relative willingness to spend and third-degree price discrimination on inbound tourism expenditure differentials

Tourism expenditures are determined by a set of antecedents that reflect tourists’ willingness and ability to spend, and de facto incremental monetary outlays at which willingness and ability is transformed into total expenditures. Based on the neoclassical theoretical argument of utility-constrained expenditure minimization, we extend the current literature by applying a sustainability-based segmentation criterion, namely, the Legatum Prosperity IndexTM to the decomposition of a total expenditure differential into tourists’ relative willingness to spend and an upper bound of third-degree price discrimination, using mean-level and conditional quantile estimates. Our results indicate that understanding the price–quantity composition of international inbound tourism expenditure differentials assists agents in the tourism industry in their quest for profit maximization.

The Importance of Price Beliefs in Consumer Search

A consumer’s decision to engage in search depends on the beliefs the consumer has about an unknown product characteristic (e.g., price). Because beliefs are rarely observed, researchers typically assume that consumers have rational expectations or update beliefs consistent with Bayesian updating. These assumptions are restrictive and do not enable the researcher or the retailer to price discriminate among consumers on the basis of heterogeneity in beliefs. The authors use Monte Carlo experiments to show how these assumptions affect estimates of search cost. Next, they design an incentive-aligned online study in which participants search over the price of a homogeneous good, and the authors elicit distributions of price beliefs before and after each search. Drawing on data collected from a nationally representative panel, they find substantial heterogeneity in prior price beliefs, such that participants update their beliefs in response to search outcomes but deviate from Bayesian updating in that they underreact to new information. Importantly, the authors show that (1) assuming Bayesian updating does not significantly bias search cost estimates at the aggregate level if the researcher accounts for heterogeneous prior beliefs, (2) eliciting heterogeneity in prior expected prices is much more important than eliciting heterogeneity in prior price uncertainty, and (3) a retailer can increase profits through third-degree price discrimination by recognizing the heterogeneity in prior beliefs.

Third-degree price discrimination in oligopoly with endogenous input costs

This paper examines the output effect of third-degree price discrimination in symmetrically differentiated oligopoly. We find that when the sellers’ input costs are chosen endogenously by an upstream supplier with market power, as opposed to being fixed exogenously, long-standing qualitative conclusions about the effect of price discrimination on aggregate output can be reversed. In contrast to previous findings (e.g., by Holmes, 1989), more intense competition in the strong market than in the weak market can make it less likely that price discrimination raises aggregate output. For linear demand functions, we establish necessary and sufficient conditions under which the output effect changes sign when input costs are endogenized.

Third-Degree Price Discrimination in Oligopoly with Endogenous Input Costs

This paper examines the output effect of third-degree price discrimination in symmetrically differentiated oligopoly. We find that when the sellers' input costs are chosen endogenously by an upstream supplier with market power, as opposed to being fixed exogenously, long-standing qualitative conclusions about the effect of price discrimination on aggregate output can be reversed. In contrast to previous findings (e.g., by Holmes 1989), more intense competition in the strong market than in the weak market can make it less likely that price discrimination raises aggregate output. For linear demand functions, we establish necessary and sufficient conditions under which the output effect changes sign when input costs are endogenized.

Disproving Elasticity Pricing or Third-Degree Price Discrimination, Again

Disproving Elasticity Pricing or Third-Degree Price Discrimination, Again