Migración

2.1 - Introduction

The objective of this chapter is to survey the main issues related to the determination of an optimal price schedule when distributional goals are specified. In section 2.2 we will be examining the concept of price discrimination, the conditions that allow its existence, the three types of price discrimination, and the possibility of imposing progressiveness or regressiveness in such pricing policy. In section 2.3 we are interested in the focus of this thesis, that is, in the use of price discrimination by public utilities: first we examine the current pricing practices adopted by these companies; in sub-section 2.3.2 we describe the relevant works in the economic literature on public utility pricing in which a distributional goal is considered or could be introduced; and finally, in sub-section 2.3.3 we review the sparse Brazilian literature on the subject. In an appendix to this chapter we examine the properties of the analytical instruments we will be using throughout this thesis, i.e., the social welfare and the utility functions.

2.2 - Discrimination and Pricing

Price discrimination is a general commercial practice. It has been used in several different contexts, including in public utility pricing with a distributional purpose, as we saw in chapter 1. The objective of this section is to examine the meaning of price discrimination and its implications since this thesis is interested in improving the distributional characteristics of the currently

used discriminatory price structures practiced by Brazilian public utilities.In this section we are going to address:

1) discuss the problem of finding an acceptable definition of price discrimination;

2) review the conditions that allow such discrimination; 3) examine the types of price discrimination currently in use in Brazil and elsewhere; and

4) consider the level of progressiveness (or regressiveness) of such price discrimination policies.

2.2.1 - Definition of Discrimination

Price discrimination occurs when different units of the same commodity are sold at different prices, either to the same or different consumers.

One can say that the problem with the above definition rests with the words "same commodity". In reality, some of those commodities being sold at different prices are not the same ones in the strict sense. Phlips (1983,p.6) cites Debreu (1959,p.33) to argue that the same good sold at different places is a different economic good at each of these locations to stress the fact that what matters is the total cost of producing and distributing the

commodity.

George and Shorey (1978,p. 126) agree with the idea of first examining the differences in costs before saying that there is price discrimination. For them price discrimination exists when commodities, whose costs are the same, are charged at different prices, or when the price differences do not correspond to cost differences. This is also the understanding of Varian (1989) who cites Stigler (1987) to say that price discrimination exists when a good is being sold at prices that are in different ratios to marginal costs. What is interesting in their definition, besides calling attention to the cost differences, is that it mentions the possibility of the differences in prices being larger than the differences in the costs of production, which in some cases may imply an intentional attitude of the seller to establish discrimination among its customers.

Price discrimination is usually thought of as a device used by a seller to maximize its profits. For instance, Phlips(1983,p.7) is thinking of a private enterprise when he emphasizes that what is typical for discrimination is the fact that the seller is looking for maximization of his overall profits when he sells to several markets at different prices. However, price discrimination can be used and has been used by government-owned public utilities in developing countries with a non-profit oriented objective, as is the case of the Brazilian public utilities we examined in chapter 1. In this case price discrimination is used to satisfy a social objective other than profit maximization.

2.2.2 - Conditions for Discrimination

Price discrimination is not always possible; for its existence some preconditions are necessary. Three usually cited requirements are:

i) resale of the commodity must be impossible or preventable; that is, nontransferability of the commodity between customers (in greater or lesser degrees) is a condition to avoid failure in the discrimination process;

ii) the seller must have the ability to sort customers; iii) the seller should have some market power.

Most authors cite the nontransferability of the commodity among consumers as an important requirement for discrimination, but fail to mention that the transferability of the demand can cause the failure of a discriminatory pricing policy. We know that this transferability occurs when a consumer chooses a pricing option that was not meant for him, as is the case of a rich commuter preferring to travel in the second class when he was supposed to choose the first class. In the case of public utilities, the distributional device built in their price schedules assumes that rich households (that is, the high demand consumers) will pay the higher prices charged to higher consumption. The empirical evidence shown in chapter 1 revealed that this assumption is not always fulfilled and that the adverse selection made by some households precludes the

adequate operation of the discriminatory pricing policy. In chapter 5 we will be examining how the self-selection mechanism used by consumers should be taken into account in order to avoid frustration of the distributional intentions imposed upon the price schedule.^

The above requirements for price discrimination are usually thought as applying to a private enterprise. However, they are equally important for a public enterprise (usually a monopoly) that uses price discrimination as a device for income redistribution.

2.2.3 - Types of Price Discrimination

Pigou (1920) discerns three basic types of price discrimination:

i) first-degree discrimination: the seller charges a different price for each unit of the commodity; this price is exactly the demand price, that is, the buyer’s reservation price for that unit. This type of discrimination is called "perfect" to characterize the fact that each unit of output has its price and this price equates the value the buyer evaluates that unit ; in the case of first-degree discrimination, the whole consumer surplus is extracted by the seller.

ii) second-degree discrimination: this type of discrimination is a variant of the first-degree type since the

It has been mentioned that the transferability of commodity prevents discrimination, while the transferability of demand may induce the producer to increase the discrimination. However, if the demand is being transferred to a lower lever of consumption and, consequently, to a lower price because the price differential is too high (this is the case examined in chapter 5), the solution is to diminish the discrimination and not to increase it.

different prices relate to blocks of units sold; instead of changing the price for each unit sold, the seller charges the same price for the quantity of units that falls within a given interval of commodity quantities, setting this price equal to the demand price the buyer is willing to pay for that quantity; as a result of this procedures, the seller charges different prices for different blocks of units bought by the consumers. The seller uses a second-degree discrimination because he has incomplete information (in the case of first-degree he must have complete information) about individual preferences, thus he is only able to extracted consumer surplus imperfectly, resorting to a pricing policy that takes into account

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