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PRICE DISCRIMINATION AND RETAIL CONFIGURATION

PRICE DISCRIMINATION AND RETAIL CONFIGURATION. INTRODUCTION. LONG-STANDING CONSENSUS AMONG ECONOMIST THAT MONOPOLY FIRM CAN PRICE DISCRIMINATE. WHAT ABOUT MULTIFIRM MARKETS??? BORK’S (1978) CLAIM THAT PERSISTENT PRICE DIFFERENCES IN MULTIFIRM MARKETS CANNOT BE DISCRIMINATORY.

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PRICE DISCRIMINATION AND RETAIL CONFIGURATION

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  1. PRICE DISCRIMINATION AND RETAIL CONFIGURATION

  2. INTRODUCTION • LONG-STANDING CONSENSUS AMONG ECONOMIST THAT MONOPOLY FIRM CAN PRICE DISCRIMINATE. • WHAT ABOUT MULTIFIRM MARKETS??? • BORK’S (1978) CLAIM THAT PERSISTENT PRICE DIFFERENCES IN MULTIFIRM MARKETS CANNOT BE DISCRIMINATORY. • BORENSTEIN 1985 & HOMES 1989 HAVE SHOWN THAT PRICE DISCRIMINATION DOES EXIST EVEN IN MULTIMARKET FIRMS.

  3. INTRODUCTION • WHILE RECENT THEORY SUPPORTS THE POSSIBILITY OF PRICE DISCRIMINATION IN MULTIFIRM MARKETS, DEMONSTRATING THAT DISCRIMINATION EXPLAINS ANY OBSERVED PRICE DIFFERENTIAL HAS BEEN DIFFICULT. • AUTHOR WANTS TO CONFIRM THAT PRICE DISCRIMINATION CAN OCCUR IN MULTIFIRM MARKETS BY USING MICRODATA ON GASOLINE RETAILING.

  4. OUTLINE • ASSUMPTIONS • SIMPLE MODEL OF PRICE DISCRIMINATION & CHARACTERIZE THE RESULTING PRICE DIFFERENTIALS & PROFIT LEVELS. • LOOK AT SOME OF THE DATA AND TABLES. • CONCLUDING COMMENTS.

  5. THE PAPER EXPLOITS A NATURAL EXPERIMENT IN WHICH FIRMS DIFFER IN THE ABILITY TO PRICE DISCRIMINATE BUT NOT IN THE COST OF PRODUCTION. DIFFERENCES IN PRICE STRUCTURES ACROSS FIRMS ARE THEN ARGUED TO BE EVIDENCE OF PRICE DISCRIMINATION. • IT COMPARES PRICE DIFFERENTIAL BETWEEN FULL-SERVICE & SELF-SERVICE GASOLINE AT STATIONS OFFERING BOTH SERVICE TYPES (MULTIPRODUCT STATIONS) WITH THE PRICE DIFFERENTIAL ACROSS STATIONS OFFERING ONLY FULL-SERVICE AND STATIONS OFFERING ONLY SELF-SERVICE (SINGLE-PRODUCT STATIONS). • ASSUME NO DIFFERENCE IN COST OF SELLING FULL & SELF SERVICE AT SAME LOCATION. GASOLINE STATION HAS SOME MARKET POWER AS A RESULT OF LOCATION/BRAND • A MULTIPRODUCT STATION WILL BE ABLE TO PRICE DISCRIMINATE BECAUSE IT CAN SET 2 PRICES WHILE A SINGLE PRODUCT STATION CAN ONLY SET ONE. • IF MULTIPRODUCT STATIONS ARE PRICE DISCRIMINATING, FULL-SERVICE PRICE WILL BE HIGHER AT THESE STATIONS & SELF-SERVICE PRICE LOWER. RAISING THE FULL-SERVICE PRICE IS LESS COSTLY TO A MULTIPRODUCT STATION BECAUSE CUSTOMERS NO LONGER WILLING TO PAY FOR FULL-SERVICE SWITCH TO SELF-SERVICE AT THE SAME LOCATION. • FOR SINGLE-PRODUCT STATION, RAISING THE PRICE FOR FULL-SERVICE WILL RESULT IN A LOSS OF CUSTOMERS.

  6. Demand & Cost {V(g)(t – pg) if she consumes one unit of service level g U = {V(0)t if she does not purchase. D(Pg) = 1 – V(g)Pg V(g) – V(0) (1) • V(f)>V(s)>V(0)>0 Df(Pf,Ps) = 1 – V(f)Ps + V(s)Ps V(f)-V(s) V(f)-V(s) Ds(Ps,Pf) = V(f)Pf - V(s)[V(f) – V(0)]Ps V(f)-V(s) [V(f) – V(s)] [V(s)-V(0)] (2)

  7. Single-Product Station Max πf ^sp= (Pf-w-a)D(pf) Full-service (3) Max πs^sp=(Ps-w)D(Ps) Self-service (4) Pf^sp= V(f)-V(0) + w+a 2V(f) 2 (5) Ps^sp=V(s)-V(0) + w 2V(s) 2 Multi-product Station Max π^mp= (Pf-a-w)Df(Pf,Ps) + (Ps-w)Ds(Ps,Pf) (6) Ps^mp = [V(f)+V(s)] [V(s)-V(0)] + 2wV(f)V(s)+ aV(f)[V(s)-V(0)] Pf^mp=2V(s) [V(f)-V(0)] + wV(s) [V(f)+V(s) ] + aV(s)[2V(f)-V(0)+V(s)] ∂ ∂ ∂ , where ∂ =3V(f)V(s)+V(f)V(0)+V(s)^2-V(s)V(0) (7)

  8. ∆mp=Pf^mp – Ps^mp • ∆sp=Pf^sp – Ps^sp, (8) • ∆=∆mp - ∆sp • ∆f=Pf^mp – Pf^sp≥0 • ∆s=Ps^mp – Ps^sp≤0 (9)

  9. Price discrimination model predicts that, compared to single-product prices, the multiproduct self-service price will be no higher (∆s≤0) & the multiproduct full-service price will be no lower (∆f≥0). • The difference in differentials will be positive (∆>0). • It also shows that if the stations face the same demand, multiproduct stations will be more profitable than either type of single-product station. • For low values of α, full-service single product stations will be more profitable than single-product self-service. • When α is large, the higher marginal cost more than offsets the greater demand for high quality.

  10. Evidence from Retail Gasoline Markets • Data used to test the price discrimination hypothesis are a cross section of retail prices & characteristics for all 1,527 stations in a 4-county area in eastern Massachusetts. • Data on station location, ancillary services, gasoline brand, station capacity, & service level(full or self) are included. • Prices used in the analysis are the minimum price at each station for the specified gasoline grade & service quality. • Data collection occurred over a 12-week period in early 1987.

  11. Table 1

  12. Prices at station I of type k (k=MP or SP) for gasoline supplied w/ service quality g (g=full or self) in market j can be represented by : • Pikgj= β0 + β1Dg + β2Dk + β3DkDg +γ1Mj + γ2MjDk +ǾXikg +€ijkg • Ordinary Least Square Estimate

  13. Conclusion • The results suggested that price differential at multi-product stations does not appear to be cost driven. Instead, gasoline stations seem to have sufficient local market power to allow multi-product stations to price discriminate, maintaining price differentials approximately twice as large as the differential at other firms. • Data suggest that price discrimination at the retail level adds at least nine cents a gallon to the average price of full-service gasoline. • While the data support the price discrimination hypothesis, the test is conducted in a single geographic area. It would be interesting to test these hypothesis in more typical environment. • It would also be better to test the effects of station density on prices, price differentials, and other parameters of the price dispersion.

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