Intertemporal Price Discrimination and Peak Load Pricing

Intertemporal price discrimination is an important and widely practiced pricing strategy closely related to third-degree price discrimination. Here consumers are separated into different groups with different demand functions by being charged different prices at different points in time.

To see how intertemporal price discrimination works, think about how an electronics company might price new, technologically advanced equipment, such as videocassette recorders during the 1970s, compact disc players in the early 1980s, and most recently, digital tape players. In Figure 11.7, Di is the (inelastic) demand curve for a small group of consumers who value the product highly and do not want to wait to buy it (e.g., stereo buffs who value high-quality sound and want the latest equipment). D2 is the demand curve for the broader group of consumers who are more willing to forgo the product if the price is too high. The strategy, then, is to initially offer the product at the high price Pi, selling mostly to consumers on demand curve D\. Later, after this first group of consumers has bought the product, the price is lowered to P2, and sales are made to the larger group of consumers on demand curve D2.10

There are other examples of intertemporal price discrimination. One involves charging a high price for a first-run movie, then lowering the price after the movie has been out a year. Another, practiced almost universally by publishers, is to charge a high price for the hardcover edition of a book, and then to release the paperback version at a much lower price about a year later.

8 Airlines also allocate the number of seats on each flight that will be available for each fare category. This is based on the total demand and mix of passengers expected for each flight. Methods for doing this are discussed in Peter R Belobaba,"Airline Yield Management: An Overview of Seat Inventory Control," Transportation Science21 (May 1987): 63-73.

"The Art of Devising Air Fares," New York Times, March 4, 1987. "The prices of new electronic products also come down over time because costs fall as producers start to achieve greater scale economies and move down the learning curve. But even if costs did not fall, producers can make more money by first setting a high price and then reducing it over time, thereby discriminating and capturing consumer surplus.

FIGURE 11.7 Intertemporal Price Discrimination. Here, consumers are divided into groups by changing the price over time. Initially, the price is high, and the firm captures surplus from consumers who have a high demand for the good and are unwilling to wait to buy it. Later,the price is reduced to appeal to the mass market.

FIGURE 11.7 Intertemporal Price Discrimination. Here, consumers are divided into groups by changing the price over time. Initially, the price is high, and the firm captures surplus from consumers who have a high demand for the good and are unwilling to wait to buy it. Later,the price is reduced to appeal to the mass market.

Many people think that the lower price of the paperback is due to a much lower cost of production, but this is not true. Once a book has been edited and typeset, the marginal cost of printing an additional copy, whether hardcover or paperback, is quite low, perhaps a dollar or so. The paperback version is sold for much less not because it is much cheaper to print, but because high-demand consumers have already purchased the hardbound edition, and the remaining consumers generally have more elastic demands.

Peak-load pricing is another form of intertemporal price discrimination. For some goods and services, demand peaks at particular times-for roads and tunnels during commuter rush hours, for electricity during late summer afternoons, and for ski resorts and amusement parks on weekends. Marginal cost is also high during these peak periods because of capacity constraints. Prices should thus be higher during peak periods.

This is illustrated in Figure 11.8, where Di is the demand curve for the peak period, and Di is the demand curve for the nonpeak period. The firm sets marginal revenue equal to marginal cost for each period, obtaining the high price PI for the peak period, and the lower price P2 for the nonpeak period, with corresponding quantities Qi and Qi. This increases the firm's profit above what it would be if it charged one price for all periods. It is also more efficient-the

Peak Load Pricing Marginal Cost

FIGURE 11.8 Peak-Load Pricing. Demands for some goods and services increase sharply during particular times of the day or year. Charging a higher price Pi during the peak periods is more profitable for the firm than charging a single price at all times. It is also more efficient because marginal cost is higher during peak periods.

sum of producer and consumer surplus is greater because prices are closer to marginal cost.11

Note that peak-load pricing is different from third-degree price discrimination. With third-degree price discrimination, marginal revenue has to be equal for each group of consumers and equal to marginal cost. The reason is that the costs of serving the different groups are not independent. For example, with unrestricted versus discounted air fares, increasing the number of seats sold at discounted fares affects the cost of selling unrestricted tickets-marginal cost rises rapidly as the airplane fills up. But this is not so with peak-load pricing (and for that matter, with most instances of intertemporal price discrimination). Selling more tickets for the ski lifts or amusement park on a weekday does not significantly raise the cost of selling tickets on the weekend. Similarly, selling more electricity during the off-peak period will not sig-11

The efficiency gain from peak-load pricing is important. If the firm were a regulated monopolist (e.g., an electric utility), the regulatory agency should set the prices Pi and Pi at the points where the demand curves, Di and Di, intersect the marginal cost curve, rather than where the marginal revenue curves intersect marginal cost. Consumers then realize the entire efficiency gain.

nificantly increase the cost of selling electricity during the peak period. As a result, price and sales in each period can be determined independently by setting marginal cost equal to marginal revenue for each period.

Movie theaters, which charge more for the evening show than for the matinee, are another example of this. For most movie theaters the marginal cost of serving customers during the matinee is independent of the marginal cost during the evening. The owner of a movie theater can determine the optimal prices for the evening and matinee shows independently, using estimates of demand in each period along with estimates of marginal cost.

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Responses

  • AWET ASFAHA
    What degree of price discrimination is peek load pricing?
    1 year ago
  • Helen
    Is peak load pricing the same as intertemporal pricing?
    6 months ago

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