Revisiting the Relationship between Competition and Price Discrimination

Abstract

dispersion. However, the subsequent literature has delivered conflicting findings. Most notably, Gerardi and Shapiro (2009) revisit the analysis in Borenstein and Rose (1994) and find precisely the opposite pattern. 1 Given this ambiguity, in this paper we revisit the relationship between market structure and price discrimination. We have three points of departure from the earlier literature. First, we build directly on early theoretical work on oligopoly price discrimination, which shows that competition can increase or decrease price differences. In particular, Borenstein (1985) and Holmes (1989) show that the effect of competition on price differences depends on whether discrimination is based on differences in consumers' underlying willingness-to-pay or differences in their degree of brand loyalty. We develop a simple model in which consumers differ along both dimensions and show that, with more than two types of consumers, competition may increase the price differential between some consumers while reducing it between others. Second, empirically, we estimate the impact of competition on price differentials rather than on overall price dispersion, which has been the focus of most previous studies. Since our theoretical model demonstrates that competition may increase price differences between some consumers while decreasing them between others, the impact on overall price dispersion is not necessarily informative about the changes in prices that take place. Finally, we exploit a novel source of data and study the Canadian airline industry rather than the US industry, which was the setting for many previous studies. There are a number of advantages to studying the Canadian setting. Most importantly, the small number of carriers operating in the domestic Canadian market means that the changes in market structure that we observe map much more closely to the simple comparison between monopoly and duopoly, which is the basis of our theoretical model and, indeed, much of the theoretical work in this area.Borenstein ( 1985) was the first to point out that while monopoly price discrimination is based on differences in consumers' underlying value of a good, oligopoly price discrimination can also be based on differences in the strength of consumers' brand preferences. Holmes (1989) then showed that a firm's price elasticity of demand in a market can be expressed as the sum of the industry-demand elasticity and the cross-price elasticity and that, with more than one firm, price discrimination can be based on differences in either elasticity. In his review article, Stole (2007) explicitly shows that with third-degree price discrimination, the relationship between competition and the price differential between consumer types will depend on whether consumers have similar or different cross-elasticities of demand. In particular, he shows that if all consumers have high cross-elasticities of demand, competition will push all prices toward marginal cost and reduce price differentials. On the other hand, if consumers with a ...

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