Timothy Van Zandt - Insead

Chapter 10
Explicit Price Discrimination
10.1 Motivation and objectives
Broadly
Figure 10.1
$
30
25
20
15
10
5
Profit
Cost
Consumer
surplus
Deadweight
loss
d(P )
2 4 6 8 10 12 14
mc(Q)
Figure 10.1 shows our familiar illustration of the deadweight loss and of the distribution
of surplus for a firm with market power. The firm’s manager is happy to see the large region
labeled “profit”, but she feels disappointed for two reasons. First, the customers are getting
away with some surplus. Second, some potential gains from trade (the deadweight loss) are
not realized and hence go to no one. Ideally, she would like to generate all possible gains
from trade and extract these gains for the firm.
Her problem is not a lack of bargaining power. Her firm can make a take-it-or-leave-it
price offer that allows for no haggling. Yet changing the price trades off consumer surplus
for deadweight loss and so cannot eliminate both of them.
Chapters 10, 11, and 12 examine more sophisticated pricing strategies that increase
profits by expanding gains from trade and reducing consumer surplus.
Firms, Prices, and Markets ©August 2012 Timothy Van Zandt
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