Quality Differences, Third‐degree Price Discrimination, and Welfare

Abstract

We propose a model with two markets to analyze the welfare implications of price discrimination with quality differences. In each market a local firm that operates in that market only competes against a global firm that operates in both markets. Local firms produce higher-quality goods than the global firm. If the quality levels of the local firms' products are the same, price discrimination is never welfare-decreasing. If they differ, discrimination is welfare-increasing if quantity increases. Because of a positive allocation effect of price discrimination, there are parameter values such that welfare increases while total output decreases with price discrimination. (JEL D43, D60) 339

National pricing with local quality competition

“…This result has some parallels toThisse and Vives (1988) who find that price discrimination is the unique equilibrium in a setting of spatially continuous demand, where two competing firms choose between uniform and location-specific prices.5 In some of our numerical examples with "strong" quality competition, the profit gain from national pricing will in many cases exceed 5% (while holding fixed the rival's choice of pricing strategy, local or national), and can also become much larger than that, exceeding 20%, when only one chain adopts national pricing.6 According to the standard terminology in the third-degree price discrimination literature, as first introduced byRobinson (1933), the profit-maximizing price is higher (lower) in the stronger (weaker) market.7 Armstrong and Vickers (2001) apply a similar model and show that oligopolistic firms benefit from price discrimination if the degree of competition is sufficiently strong.8 Our result that consumers in all markets might benefit from uniform pricing is in stark contrast to the result derived byAdachi and Matsushima (2014), who study the welfare effects of third-degree price discrimination in oligopolistic markets with horizontal product differentiation and symmetric demand in each market. They find that uniform pricing leads to consumer losses in weak markets that are always higher than the corresponding consumer gains in strong markets, causing an overall reduction in consumers' surplus.9 In the literature on third-degree price discrimination there are some papers that incorporate a quality dimension, but typically either in a monopoly framework (e.g.,Ikeda & Toshimitsu, 2010) or with exogenous quality differences between firms (e.g.,Galera et al, 2017). None of these papers analyze how the presence of local quality competition affects the incentives for national versus local pricing in retail markets.10 In a robustness check (Section 7) we show that our main results do not critically hinge on the assumption of symmetric demand.11 Allowing the chains the choice to introduce national quality standards would make the analysis much more involved.…”

“…In the literature on third-degree price discrimination there are some papers that incorporate a quality dimension, but typically either in a monopoly framework (e.g.,Ikeda and Toshimitsu, 2010) or with exogenous quality di¤erences between …rms (e.g.,Galera et al, 2017). None of these papers analyze how the presence of local quality competition a¤ects the incentives for national versus local pricing in retail markets.5 This result has some parallels toThisse and Vives (1988) who …nd that price discrimination is the unique equilibrium in a setting of spatially continuous demand, where two competing …rms choose between uniform and location-speci…c prices.…”

“…99In the literature on third‐degree price discrimination there are some papers that incorporate a quality dimension, but typically either in a monopoly framework (e.g., Ikeda & Toshimitsu, 2010) or with exogenous quality differences between firms (e.g., Galera et al, 2017). None of these papers analyze how the presence of local quality competition affects the incentives for national versus local pricing in retail markets.…”

Does Price Discrimination Increase Social Welfare?

“…So, for third-degree price discrimination to improve social welfare, it must lead to a big increase in total output to make up for the way the market is misallocating resources [17]. Galera [18] studied how price discrimination affects welfare when quality disparities exist. Their findings indicate that when local firms' product qualities are identical, price discrimination consistently leads to an increase in welfare, primarily driven by a positive allocation effect associated with price discrimination.…”

On the effects of antitrust policy intervention in pricing strategies in a distribution channel

“…weak) market. Galera et al (2017) propose a model with two markets such that a low-end retailer operating in both markets faces a high-end competitor in each market, and show that price discrimination enhances welfare when it increases quantity.…”