Price Discrimination in Merger Analysis

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CHAPTER X

PRICE DISCRIMINATION IN MERGER ANALYSIS

A. Introduction

Price discrimination occurs when at least two groups of customers

pay different prices for a particular product despite the similarity in the

marginal cost of serving each group. Economists study price

discrimination not only as an interesting empirical question in its own

right, but also for its public policy implications.1 These fall into two

general categories. The first is the equitable treatment of various groups

of consumers.2 The second relates to price discrimination’s impact on

1. This chapter does not address discrimination in the legal sense prohibited

by the Robinson-Patman Act. However, some of the analysis here can be

relevant in particular Robinson-Patman Act cases. The focus here is on

price discrimination as a device for defining markets and determining the

competitive impact of mergers on similar transactions.

2. Studies that examine price discrimination along racial, gender,

educational or income dimensions include Pinelopi Koujianou Goldberg,

Dealer Price Discrimination in New Car Purchases: Evidence from the

Consumer Expenditure Survey, 104 J. POL. ECON. 622 (1996); Kathryn

Graddy, Do Fast-Food Chains Price Discriminate on the Race and

Income Characteristics of an Area?, 15 J. BUS. & ECON. STUD. 391

(1997); Faye Steiner, Quantifying Discrimination in Home Mortgage

Lending: Estimation of Loan Price Elasticies Across Products and Races

(Stanford Inst. for Econ. Policy Research, Discussion Paper No. 00-15,

1999), available at http://siepr.stanford.edu/papers/pdf/00-15.pdf; Jerry

Hausman & J. Gregory Sidak, Do Long Distance Carriers Price

Discriminate Against the Poor and the Less-Educated? (2002), available

at http://www.criterioneconomics.com/articles/sidak_2.pdf; and Fiona

Scott Morton, Florian Zettelmeyer & Jorge M. Silva-Risso, Consumer

Information and Price Discrimination: Does the Internet Affect the

Pricing of New Cars to Women and Minorities? (Yale School of Mgmt.,

248 Econometrics

total welfare.3 In evaluating a proposed merger, the presence or absence

of price discrimination has additional importance when defining relevant

markets and evaluating the merger’s competitive effects.4

With price discrimination, firms have a degree of market power, in

the sense that certain customer groups’ demand curves facing each firm

are downward sloping, and therefore prices exceed marginal cost for

some customers.5 The existence of price discrimination, however, says

little about the level of market power or the state of competition in the

market.6 However, in evaluating a merger, the critical issue is whether

Working Paper No. ES-15, 2002), available at

http://ssrn.com/abstract=288527.

3. The existence of price discrimination has ambiguous effects on

deadweight loss. In theory, perfect, or first-degree, price discrimination

eliminates all deadweight loss by allowing the seller to increase quantity

up to the point where the price paid by the lowest priced customer equals

marginal cost. Under imperfect, or third-degree, price discrimination,

deadweight loss may be greater or lesser with price discrimination as

compared to a single price for all customer groups, depending on the

effect on total output. See Hal R. Varian, Price Discrimination, in 1

HANDBOOK OF INDUS. ORG. 597 (1989). Frederick G. Tiffany & Jeff A.

Ankrom, The Competitive Use of Price Discrimination by Colleges, 24 E.

ECON. J. 99 (1998), for example, find that price discrimination in

colleges’ use of financial aid increases enrollment and thereby reduces

deadweight loss.

4. The equity and welfare implications of price discrimination matter in

cases where a merger is likely to transform a market without price

discrimination into one with price discrimination.

5. This follows from the fact that prices between groups differ while

marginal cost is identical. Therefore, at least one of the two sets of

customers must be paying a price greater than marginal cost.

6. Indeed, firms may increase the level of price discrimination by offering

discounts to particular classes of customers in response to increased

competition. For example, manufacturers of brand name prescription

drugs offer deep discounts off list price on drugs that face competition for

sales to HMOs and other managed care customers, or to large public

sector purchasers See, e.g, Patricia M. Danzon, Price Discrimination for

Pharmaceuticals: Welfare Effects in the US and the EU, 4 INT’L J. ECON.

BUS. 321 (1997); Teresa L. Kauf, Price Discrimination and Bargaining

Power in the US Vaccine Market: Implications for Childhood