1
Chapter 12
Pricing
Key issues
1. why and how firms price discriminate
2. perfect price discrimination
3. quantity discrimination
4. multimarket price discrimination
5. two-part tariffs
6. tie-in sales
Applications and problems
1.Broadway theaters
2.Providian tries to perfectly price
discriminate
3.Amazon dynamic pricing
4.Coca Cola: Japan & U.S.
5.IBM requirement ties
6.eBay auctions
Nonuniform pricing
• prices vary across customers or units
• noncompetitive firms use nonuniform
pricing to increase profits
Single-price firm
• nondiscriminating firm faces a trade-off
between charging
• maximum price to consumers who really want
good
• low enough price that less enthusiastic
customers still buy
• as a result, single-price firm usually sets an
intermediate price

Price-discriminating firm
• avoids this trade-off
• earns a higher profit by charging
• higher price to those willing to pay more than
the uniform price: captures their consumer
surplus
• lower price to those not willing to pay as much
as the uniform price: extra sales
2
Extreme examples of tradeoff
• maximum customers will pay for a movie:
• college students, $10
• senior citizens, $5
• theater holds all potential customers, so MC
= 0
• no cost to showing the movie,
so π = revenue
Example 12.1a
$200$100$100
Price
discriminate
$100$0$100Uniform, $10
$150$100$50Uniform, $5
Total
Profit
Profit from
20 Seniors
Profit from 10
College Students
Pricing

Example 12.1b
$125$25$100Price
discriminate
$100$0$100Uniform, $10
$75$25$50Uniform, $5
Total
Profit
Profit from
5 Seniors
Profit from 10
College Students
Pricing
Broadway theaters
increase their profits 5% by price
discriminating rather than by setting
uniform prices
Geographic price discrimination
• admission to Disneyland is $38 for out-of-
state adults and $28 for southern
Californians
• tuition at New York’s Fordham University
is $4,000 less for commuting first-year
students than for others
Successful price discrimination
• requires that firm have market power
• consumers have different demand
elasticities, and firm can identify how
consumers differ
• firm must be able to prevent or limit
resales to higher-price-paying customers

by others
3
Preventing resales
• resales are difficult or impossible when
transaction costs are high
• resales are impossible for most services
Prevent resales by raising
transaction costs
• price-discriminating firms raise transaction
costs to make resales difficult
• applications:
• U.C. Berkeley requires anyone with a student
ticket to show a student picture ID
• Nikon warranties cover
only cameras sold in this
country
Prevent resales by vertically
integrating
• VI: participate in more than one successive
stage of the production and distribution
chain for a good or service
• VI into the low-price purchasers
Prevent resales by government
intervention
• governments require that milk producers charge
higher price for fresh use than for processing
(cheese, ice cream) and forbid resales
• governments set tariffs limiting resales by making
it expensive to import goods from lower-price
countries

• governments used trade laws to prevent sales of
certain brand-name perfumes except by their
manufacturers
Flight of the Thunderbirds
• 2002 production run of 25,000 new Thunderbirds included
only 2,000 for Canada
• potential buyers are besieging Ford dealers in Canada
• many hope to make a quick profit by reselling these cars in the
United States
• reselling is relatively easy and shipping costs are relatively low
• why ship a T-Bird south?
• Ford is price discriminating between U.S. and Canadian customers
• at the end of 2001, Canadians were paying $56,550 Cdn.
(Thunderbird with the optional hardtop), while U.S. customers
were spending up to $73,000 Cdn.
Thunderbirds (cont.)
• Canadian dealers try not to sell to buyers who will export
the cars
• dealers have signed an agreement with Ford that explicitly
prohibits moving vehicles to the United States
• dealers try to prevent resales because otherwise Ford may cut off
their Thunderbirds or remove their dealership license
• one dealer said, “It’s got to the point that if we haven’t sold
you a car in the past, or we don’t otherwise know you,
we’re not selling you one.”
• nonetheless, many Thunderbirds were exported: eBay
listed dozen of these cars on a typical day
4
3 types of price discrimination
• perfect price discrimination (first-degree): sell

each unit for the most each customer is willing to
pay
• quantity discrimination (second-degree): charges
a different price for larger quantities than for
smaller ones
• multimarket price discrimination (third-degree):
charge groups of customers different prices
Perfect-price-discriminating
monopoly
• has market power
• can prevent resales
• knows how much each customer is willing
to pay for each unit purchase (all knowing)
All-knowing monopoly
sells each unit at its reservation price
• maximum price consumers will pay (captures
all possible consumer surplus)
• height of demand curve
• MR is the same as its price (AR)
Figure 12.1 Perfect Price Discrimination
p, $ per unit
6
5
4
3
2
1
Q, Units per day
6543210
MC

e
Demand, Marginal revenue
MR
1
= $6 MR
2
= $5 MR
3
= $4
Perfect price discrimination
properties
• perfect price discrimination is efficient
• competition and a perfectly discriminating
monopoly
• sell the same quantity
• maximize total welfare: W = CS + PS
• have no deadweight loss
• consumers worse off (CS = 0) than with
competition
s
c
d
p, $ per unit
E
D
C
B
A
Q, Units per dayQQ=
Q

MC
s
Demand, MR
MR
s
p
c
= MC
c
e
c
e
s
p
s
p
1
MC
1
MC
d
5
Providian Bancorp
• sends middle- and lower-income consumers
who need to borrow substantial sums of
money fliers that offer “the lowest interest
rate”
• when a customer calls, an employee uses a
computer model and the individual's credit
history to negotiate a customized (high)

interest rate, credit line, and other terms
Doctors perfectly price
discriminate
• “selfless” doctor charges poor patients less:
charitable or price discriminating?
• many doctors ask patients where they live,
what’s their job, and other non-medical
questions
• answers help doctor estimates patient’s
earnings/wealth and hence willingness to
pay
Amazon
• in 2000, Amazon revealed that it used “dynamic
pricing”: gauges shopper’s desire and means,
charges accordingly
• example
• a man ordered DVD of Julie Taymor’s “Titus” at
$24.49
• checks back next week and finds price is $26.24
• removes cookie: price fell to $22.74
• after newspaper articles, Amazon announced it
had dropped this policy
Botox revisited
• how much more would Allergan earn from
Botox if it could perfectly price
discriminate?
Application Botox Revisited
p
,
$ per

vial
1.30 2.612.75
A
≈
$187.5
million
C≈ $187.5 million
B ≈$375 million
Demand
Q, Million daily doses of Botox
75.0
7.5
0
e
s
e
MC
MR
143.0
c
Solved problem
How does welfare change if firm in Table
12.1 goes from charging a single price to
perfectly price discriminating?
6
Table 12.1a
$200$100$100
Price
discriminate
$100$0$100Uniform, $10

$150$100$50Uniform, $5
Total
Profit
Profit from
20 Seniors
Profit from 10
College Students
Pricing
Answer: Panel a
• welfare is same with single price or price
discrimination because output unchanged
• single price: if theater sets a single price of $5
• it sells 30 tickets and π = $150
• 20 seniors pay their reservation price so CS = 0
• 10 college students (reservation prices of $10) have CS
= $50
• welfare = $200 = profit ($150) + consumer surplus
($50)
If firm perfectly price
discriminates
• it charges all customers their reservation
price so there’s no consumer surplus
• seniors pay $5 and college students, $10
• firm's profit rises to $200
• welfare
W = $200 = profit ($200) + CS ($0)
is same under both pricing systems where
output stays the same
Table 12.1b
$125$25$100Price

discriminate
$100$0$100Uniform, $10
$75$25$50Uniform, $5
Total
Profit
Profit from
5 Seniors
Profit from 10
College Students
Pricing
Answer: Panel b
• welfare is greater with perfect price discrimination
where output increases
• if theater sets single price of $10
• only college students attend and have CS = 0
• π = $100
• W = $100
• if it perfectly price discriminates:
• CS = 0
• π =$125
• W = $125
Quantity discrimination
• firm does not know which customers have highest
reservation prices
• firm might know most customers are willing to
pay more for first unit (demand slopes down)
• firm varies price each customer pays with number
of units customer buys
• price varies only with quantity: all customers pay the
same price for a given quantity

• note: not all quantity discounts are a form of price
discrimination
7
Utility block pricing
• public utility (electricity, water, gas…)
charges
• one price for the first few units (a block) of
usage
• different price for subsequent blocks
• both declining-block and increasing-block
pricing are common
p
1
, $ per unit
30
50
70
90
Q, Units per day
20 40 900
m
(a) Quantity Discrimination
Demand
A =
$200
C =
$200
B =
$1,200
D =

$200
p
2
, $ per unit
30
60
90
Q, Units per day
30 900
m
(b) Single-Price Monopoly
Demand
F = $900
G
=
$450
MR
E = $450
Figure 12.3 Quantity Discrimination
Multimarket price discrimination
• firm knows only which groups of customers
are likely to have higher reservation prices
than others
• firm divides potential customers into two or
more groups
• firms set a different price for each group
Theater
• senior citizens pay a lower price than
younger adults at movie theaters
• by admitting people as soon as they

demonstrate their age and buy tickets,
theater prevents resales
International price
discrimination: Cars
• even including shipping and customs,
European price for BMW 750IL
• price is 13.6% more from an American firm
than imported from Europe
International price
discrimination: Software
• Australia's Prices Surveillance Agency
criticized American software industry for
charging Australians 49% more than
Americans,
• then, Agency called for an end to import
restrictions so that Australian retailers could
import software directly
8
Price discriminating: 2 groups
• marginal cost = m
• monopoly charges Group i members p
i
for
Q
i
units
• profit from Group i is
π
i
= p

i
Q
i
–mQ
i
To maximize total profit
• monopoly sets its quantities so that
marginal revenue for each group i, MR
i
,
equals common marginal cost, m:
MR
1
= m = MR
2
.
• example: Sony’s Aibo robot dog
p
J
, $ per unit
Q
J
, Units per year
DWL
J
D
J
CS
J
π

J
MR
J
p
J
= 2,000
500
3,500
0
MC
Q
J
= 3,000 7,000
(a) Japan
Figure 12.4 Multimarket Pricing of Aibo
p
US
, $ per unit
Q
US
, Units per year
DWL
US
D
US
CS
US
π
US
MR

US
p
US
= 2,500
500
4,500
0
MC
Q
US
= 2,000 4,500
(b) United States
Profit-maximizing condition
• MR
i
= p
i
(1 + 1/ε
i
), so
• MR
1
=p
1
(1 + 1/ε
1
) = m = p
2
(1 + 1/ε
2

) = MR
2
2
1
2
1
1
1
.
1
1
p
p
ε
ε

+


⇒ =

+


Solved problem
• monopoly sells in two markets
• constant elasticity of demand is
• ε
1
= -2 in first market

• ε
2
= -4 in second market
• MC = $1
• resales are impossible
• what prices should monopoly charge?
Answer
⇒
p
1
= 1/(1 – ½) = 2
p
2
= 1/(1 – ¼) = 4/3
p
1
/p
2
= 2/(4/3) = 1.5
1
11
i
i
pMC
ε

+= =


1

1/ 1
i
i
p
ε

=+


9
Coca-Cola Version 1
• a two-liter bottle of Coke costs 50% more in
the U.K. than in EU nations
(SF Chronicle, May
17, 2000: D2)
• if Coke’s marginal cost is the same for all
European nations, how does the demand in
the U.K. differ from that in the EU?
Answer
• p
UK
/p
EU
= 1.5
• an example that is consistent with this ratio
is ε
UK
= - 2 and ε
EU
= -4

• generally:
or 1.5ε
EU
- ε
UK
= 0.5 ε
UK
ε
EU
11
1/1 1.5
EU UK
εε

++=


Coca-Cola Version 2
• Japanese consumers can buy U.S made or
Japanese-made Coke (identical except for
packaging)
• wholesale prices: m
US
= $11.50, m
J
=
$20.00
• retail prices: p
US
= $18.30, p

J
= $27.40
• what are the elasticities?
Answer
• (note: example of product differentiation
rather than price discrimination)
• p(1 + 1/ε) = m, or ε = 1/(m/p –1)
• Japanese-made Coke:
ε
J
= 1/(20/27.40-1) = -3.703
• American-made Coke:
ε
US
= 1/(11.50/18.30-1) = -2.691
Generics and brand-name loyalty
Why do prices of some brand-name
pharmaceutical drugs rise when equivalent,
generic brands enter the market?
Entry of generics
• generics enter when patent for profitable drug
expires
• generics: 40% of U.S. pharmaceutical sales by volume
• name-brand drugs with sales of about $20 billion went
off patent by 1997
• most states allow/require pharmacist to switch
prescription from more expensive brand-name
product to generic unless doctor or patient object
10
Price effects

18 major orally-administered drug products that
faced generic competition 1983-1987
• on average for each drug, 17 generic brands entered and
captured 35% of total sales in first year
• price effects
• brand-name drug prices rose an average of 7%
• but average market price fell over 10%
• because generic price was only 46% of brand-name price
Explanation
• customers with different demand elasticities
• some are price sensitive: willingly switch to less
expensive generic drugs
• others are unwilling to change brands
• AARP survey found that people 65 and older are 15%
less likely than people 45 to 64 to request generic
versions of a drug from their doctor or pharmacist
• introduction of generics makes demand facing
brand-name drug less elastic
Identifying an individual’s group
• identify using observable characteristics of
consumers price elasticities
• identify consumers based on their actions:
consumers self-select into a group
Why firms use self-identification
• each price discrimination method requires
that, to receive a discount, consumers incur
some cost, such as their time
• otherwise, all consumers would get a
discount
• by spending extra time to obtain a discount,

price-sensitive consumers differentiate
themselves from others
Getting consumers to identify
themselves: Coupons
• self-selection: people who spend their time
clipping coupons buy goods at lower prices
than those who value their time more
• coupon-using consumers paid $24 billion
less than other consumers in the first half of
1990s
Airline tickets and hotel rooms
• self-selection (business vs. vacation
travelers): cheap fares require advanced
purchase and staying over a Saturday night
• Sheraton and other hotel chains offer
discounts for rooms booked 14 days in
advance for the same reason
11
Reverse Auctions
• priceline.com uses a name-your-own-price
or reverse-auction to identify price sensitive
customers
• a customer enters a relatively low price bid
for a good or service, such as airline tickets
• merchants decide whether to accept that bid
or not
Why priceline works
• to keep their less price-sensitive customers from using this
method, airlines force successful Priceline bidders to be
flexible:

• to fly at off hours
• to make one or more connection
• to accept any type of aircraft
• when bidding on groceries, a customer must list “two or
more brands you like.”
• as Jay Walker, Priceline’s founder said, “The
manufacturers would rather not give you a discount, of
course, but if you prove that you’re willing to switch
brands, they’re willing to pay to keep you.”
Welfare effects of multimarket
price discrimination
• multimarket price discrimination results in
inefficient production and consumption
• welfare under multimarket price
discrimination is lower than under
competition or perfect price discrimination
• welfare may be lower or higher with
multimarket price discrimination than with
a single-price monopoly
Gray markets
• producers of recordings, books, sunglasses,
and shampoo, price discriminate by selling
these goods for higher prices in U.S. than in
foreign markets
• if the price differential is great enough, some
goods are reimported into U.S. and sold in a
$130 billion-a-year "gray market" by
discounters (Costco, Target, Wal-Mart)
Gray markets (cont.)
• 1995 federal court decision:

• copyright owners has exclusive right to control
marketing
• can prevent reimportation
• 1998 Supreme Court decision reversed:
• discount retailers had the legal right to sell
copyrighted U.S. goods in U.S.
• once sold, "lawfully made" copies can be resold
without the permission of copyright holder
• reduces firms ability to price discriminate
Other forms of nonlinear pricing
• two-part tariffs
• tie-in sales
both are second-degree price discrimination
schemes where the average price per unit
varies with the number of units consumers
buy
12
Two-part tariff
• firm charges a consumer
• lump-sum fee (first tariff) for right to buy any
units
• constant price (second tariff) on each unit
purchased
• because of lump-sum fee, consumers pay
more, the fewer units they buy
Two-part tariff examples
• telephone service: monthly connection fee,
price per minute of use
• car rental firms: charge per-day, price per
mile

Personal seat license
• Carolina Panthers introduced the PSL in
1993, and at least 11 NFL teams used a PSL
by 2002
• over $700 million has been raised by the PSL
portion of this two-part tariff
• Raiders football season tickets: “personal seat
license” at $250-$4,000 (right to buy season
tickets for next 11 years), tickets
$40-$60 each
Two-part tariff with identical
consumers
monopoly that knows its customers' demand
curve can set a two-part tariff that has same
properties as perfect-price-discriminating
equilibrium
Two-part tariff with nonidentical
consumers
• suppose two customers - Consumer 1 and
Consumer 2 - with demand curves, D
1
and
D
2
• consider two cases, monopoly
• knows customers’ demand curves and can
charge them different prices
• cannot distinguish between types of customers
or cannot charge consumers different prices
Can distinguish/discriminate

• monopoly knows customers’ demand curves; can
charge them different prices
• monopoly charges each customer p = MC = m =
$10/unit
• thus, makes no profit per unit but sells number of
units that maximizes potential CS
• monopoly sets lump-sum fees = potential CS
• A
1
+ B
1
+ C
1
= $2,450 to Consumer 1
• A
2
+ B
2
+ C
2
= $4,050 to Consumer 2
• monopoly's total profit= $6,500
13
Figure Two-Part Tariff with Identical Consumers
p, $ per unit
q
1
, Units per day
60 70 80
D

1
80
20
10
0
m
B
1
=
$600
C
1
= $50
A
1
= $1,800
Cannot distinguish/discriminate
• monopoly cannot distinguish between types of
customers or cannot charge them different prices
• monopoly has to charge each consumer the same
lump-sum fee and same p
• due to legal restrictions, telephone company
charges all residential customers same monthly fee
and same fee per call, even though company
knows that consumers' demands vary
p , $ per unit
q
1
, Units per day
607080

D
1
80
20
10
0
m
(a) Consumer 1
B
1
=
$600
C
1
=$50
A
1
=$1,800
Figure 12.5 Two-Part Tariff
p, $ per unit
q
2
, Units per day
9010080
D
2
20
10
0
m

(b) Consumer 2
B
2
=$800
C
2
=$50
A
2
=$3,200
100
Monopoly doesn’t capture all CS
• monopoly charges lump-sum fee equal to
potential CS
1
or CS
2
• because CS
2
> CS
1
both customers buy if lump-
sum fee = CS
1
• Consumer 2 buys if monopoly charges lump-
sum fee = CS
2
• in Figure 12.5, monopoly maximizes its
profit by setting lower lump-sum fee and
charging p = $20 > MC

Why is price > marginal cost?
• by raising its price, monopoly earns more
per unit from both types of customers but
lowers its customers’ potential CS
• if monopoly can capture each customer's
potential CS by charging different lump-
sum fees, it sets p = MC
Tie-in sales
• customers can buy one product only if they
purchase another product as well
• most tie-in sales increase efficiency by
lowering transaction costs
14
2 forms of tie-in sales
• requirements tie-in sale: customers who buy
one product from a firm must purchase all
units of another product from that firm
(copiers/toner or service)
• bundling (or a package tie-in sale): two
goods are combined so that customers
cannot buy either good separately
(shoes/shoelaces)
Requirement tie-in sales
• firm cannot tell which customers are going
to use its product most (highest willing to
pay)
• firms uses requirement tie-in sale to identify
heavy users
IBM requirement tie
• 1930s: IBM produced card punch machines,

sorters, and tabulating machines that
computed using punched cards
• IBM leased (rather than sold) punch
machines; lease would terminate if
customer used non-IBM card
• by leasing, IBM avoided resale problems
and forced customers to buy cards from it
Bundling
• bundling allows firms that can't directly
price discriminate to charge customers
different prices
• profitability of bundling depends on
customers’ tastes and ability to prevent
resales
Selling Raiders' season tickets
• suppose stadium can hold all potential
customers, so MC = 0 for selling one more
ticket
• should Raiders bundle tickets for preseason
(“exhibition”) and regular-season games, or
sell separately?
Table 12.3 Bundling of Tickets to Football Games
15
When bundling increases profit
• bundling likely to increase profit if consumers'
demands are
• negatively correlated:
• consumers who value one good much more than other
customers value other good less
• here, bundling pays only if customers willing to

pay relatively more for regular-season tickets are
not willing to pay as much as others for preseason
tickets and vice versa
Supreme Court on tie-in sales
• Kodak was prohibited by the Supreme
Court from using certain tie-in sales in 1992
• Kodak sells photocopiers and Kodak parts
and service to its customers
• Kodak refused to supply some parts to
independent repair firms - effectively
forcing customers to buy those parts and
associated service from Kodak
Charge and response
• company was charged with illegally tying sale of
its photocopiers with its parts and service
• Kodak argued that
• case should be dismissed because both sides agreed
Kodak faced substantial competition in initial sale of
photocopiers
• customers would not buy from Kodak if they knew that
they would be overcharged on repair parts and service
• because Kodak didn't have market power in copier
market, it couldn't price discriminate or extend its
market power to another market
Supreme Court rejects Kodak
• consumers may be uninformed (can’t forecast
repair cost)
• even if Kodak lacks market power in
photocopiers, it’s a monopoly supplier of its
unique repair parts

• factual investigation needed to determine if
consumers are ignorant and have to be protected
• (Court did not explain consumer benefit if Kodak
forced to sell repair parts to independent repair
shops at prices set by Kodak)
eBay (English) auctions
• eBay conducts auctions on millions of items
• usually, a seller sets a minimum bid and
then buyers submit their bids up to their
maximum willingness to pay
• if a new bidder places a bid > current
highest bid, then new highest bid listed on
eBay’s computer is the previous highest bid
plus an increment (50¢ for low-price items)
Winner
• eBay auction allocates good to highest bidder at a
price equal to maximum willingness to pay of
second highest bidder plus an increment
• a seller is a monopoly and wants to obtain the
highest price
• how should the monopoly set its minimum bid
price?
• Bulow and Roberts (1989) answer this question
using principles of price discrimination
16
Setting minimum bid
• in an ascending (English) auction, high bidder wins at a
price just above that of next highest bidder
• thus, if no one else bids, high bidder obtains good for
minimum bid

• seller has an incentive not to set an extremely low
minimum bid
• however, a relatively high minimum bid dissuades some
bidders from entering auction (who force eventual winner
to pay a higher price)
• thus, seller should set the minimum bid taking account of
this tradeoff
Common value auctions
• Bajari and Hortacsu (2003) use sophisticated econometric
techniques to analyze eBay auctions for collectable coins
• because many collectors resell their coins to other
collectors, they should all place a common value on any
given coin
• in a common value auction, winning bidders should worry
that they have overbid—suffered from the winner’s
curse—because they over estimated this common value
• sophisticated bidders should therefore reduce their bids in
common value auctions as the number of bidders increase
Coin auctions
• typical collectible coin auction: minimum
bid averages about 70% of current retail
market value
• more bidders enter the auction when
minimum bids are low:
• about 4 to 5 bidders show up when the reserve
price is zero
• only 2 if the minimum bid is set at 80% of retail
price
Coin auctions (cont.)
• bidders recognize the winner’s curse and reduce

their bids by 3.2% for each additional bidder in
auction
• optimal minimum bid that maximizes expected
seller revenue is about 10-20 percent below the
current retail price
• conclude eBay sellers do a good job of setting
minimum bids to capture consumer surplus of the
high bidder
1. Why and how firms price
discriminate
• to successfully price discriminate a firm needs
• market power
• to know which customers will pay more for each unit of
output
• to prevent resales
• firm earns a higher profit from price
discrimination than uniform pricing because it
• captures some or all of the CS of customers who are
willing to pay more than uniform price
• sells to some people who won’t buy at uniform price
2. Perfect price discrimination
• to perfectly price discriminate, firm must know
maximum amount each customer is willing to pay
for each unit of output.
• perfectly price discriminating firm captures all
potential consumer surplus
• sells efficient (competitive) level of output
• compared to competition
• welfare is same
• consumers are worse off

• firms are better off
17
3. Quantity discrimination
• some firms charge customers different
prices depending on how many units they
purchase
• doing so raises their profits
4. Multimarket price
discrimination
• firm does not have enough information to
perfectly price discriminate but knows relative
elasticities of demand of groups of customers
• firm charges each group a price in proportion to its
elasticity of demand
• welfare under multimarket price discrimination is
• < under competition/perfect price discrimination
• > or < under single-price monopoly
5. Two-part tariffs
• by charging consumers a fee for the right to
buy and a price per unit, firms may earn
higher profits than from charging only for
each unit sold
• if a firm knows demand curves of its
customers, it can use two-part tariffs
(instead of perfectly price discriminating) to
capture all consumer surplus
6. Tie-in sales
• firm may increase its profit by using a tie-in sale:
customers can buy one product only if they also
purchase another one

• requirement tie-in sale: customers who buy one
good must make all of their purchases of another
good or service from that firm
• bundling (package tie-in sale): firm sells only a
bundle of two goods together
• prices differ across customers under both types of
tie-in sales
Docking Their Pay
• 2002 dispute between
• the International Longshore and Warehouse Union
(ILWU)
• shipping companies, represented by the Pacific
Maritime Association
• led to the closure of 29 west coast ports for 12
days and significant damage to U.S. and foreign
economies
• these docks handle about $300 billion worth of
goods per year
Lockout
• shippers locked out 10,500 union workers
• lockout: an action by the employers that
causes a work stoppage similar to what
would happen if the union called a strike
18
Damages
• by one estimate, the shutdown inflicted up to $2
billion a day in damages of the U.S. economy
• revenues fell 80% at West Coast Trucking
• one of Hawaii’s largest moving companies declared
bankruptcy as a consequence

• Singapore’s Neptune Orient Lines said that the
shutdown cost it $1 million a day
• Had the shutdown lasted longer, vast amounts of
food and other perishables waiting to be shipped
would have spoiled.
Why
• these events were triggered by the
expiration of a union contract
• dispute had more to do with employment
issues than wages
Background
• number of dock workers has shrunk over
the years as firms have used automation to
become more efficient
• 10,500 registered union workers averaged at
least $80,000 (some estimates set the figure
at $100,000) a year with benefits and other
perks worth about $42,000 under the
previous contract
Offer
Pacific Maritime Association negotiators
had offered
• $1 billion worth of new pension benefits—
lifetime benefits of $50,000 a year
• higher salaries of $114,500 a year for longshore
workers and $137,500 for marine clerks
• health care plan with no deductibles
Union Concerns
• use of new technologies
• potential loss of 400 longshore positions

• wanted guarantees that new clerical
positions would be filled by their union
members
Take-it-or-leave it
• Traditionally, longshore unions offered employers
a take-it-or-leave-it choice:
• union specified both a wage and a minimum
number of hours of work that the employers had to
provide
• 1975 U.S. Department of Labor study found 2/3 of
transportation union contracts (excluding railroads
and airplanes) had wage-employment compared to
only 11% of union contracts in all industries
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Task
Compare equilibrium where a union
specifies both wages and hours of work to
the perfect price discrimination equilibrium
w
w*
H*
H
H, Hours per year
w, wage per hour
B
C
Demand
Supply
A