CHAPTER 11 • Pricing with Market Power 405 $/Q P1 F IGURE 11.4 P0 SECOND-DEGREE PRICE DISCRIMINATION P2 AC P3 MC D MR Q1 1st Block Q0 2nd Block Q2 Q3 Different prices are charged for different quantities, or “blocks,” of the same good Here, there are three blocks, with corresponding prices P1, P2, and P3 There are also economies of scale, and average and marginal costs are declining Second-degree price discrimination can then make consumers better off by expanding output and lowering cost Quantity 3rd Block CREATING CONSUMER GROUPS In each case, some characteristic is used to divide consumers into distinct groups For many goods, for example, students and senior citizens are usually willing to pay less on average than the rest of the population (because their incomes are lower), and identity can be readily established (via a college ID or driver’s license) Likewise, to separate vacationers from business travelers (whose companies are usually willing to pay higher fares), airlines can put restrictions on special low-fare tickets, such as requiring advance purchase or a Saturday night stay With the liquor company, or the premium versus nonpremium (e.g., supermarket label) brand of food, the label itself divides consumers; many consumers are willing to pay more for a name brand even though the nonpremium brand is identical or nearly identical (and might be manufactured by the same company that produced the premium brand) If third-degree price discrimination is feasible, how should the firm decide what price to charge each group of consumers? Let’s think about this in two steps We know that however much is produced, total output should be divided between the groups of customers so that marginal revenues for each group are equal Otherwise, the firm would not be maximizing profit For example, if there are two groups of customers and the marginal revenue for the first group, MR1, exceeds the marginal revenue for the second group, MR2, the firm could clearly better by shifting output from the second group to the first It would this by lowering the price to the first group and raising the price to the second group Thus, whatever the two prices, they must be such that the marginal revenues for the different groups are equal We know that total output must be such that the marginal revenue for each group of consumers is equal to the marginal cost of production Again, if this were not the case, the firm could increase its profit by raising or lowering total output (and lowering or raising its prices to both groups) For example, suppose that marginal revenues were the same for each group of consumers but that marginal revenue exceeded marginal cost The firm could then make