Price discrimination (Value-based pricing) involves charging different prices to different consumers for the same good in order to increase profit.
There are two important conditions for this scheme to work:
1. The seller must be able to segregate the market at a reasonable cost.
2. The second condition is that resale must be impossible or impractical.
Price discrimination frequently reduces the deadweight loss associated with a monopoly seller!
the profit maximizing monopolist that did not, or could not, price discriminate left 50 customers unsupplied who were willing to pay $5 for a good that had a zero MC. This is a deadweight loss of $250 because 50 seniors and youth valued a commodity at $5 that had a zero MC. Their demand was not met because, in the absence of an ability to discriminate
between consumer groups, Family Flicks made more profit by satisfying the demand of the
prime-age group. But in this example, by segregating its customers, the firm’s profit maximization behaviour resulted in the DWL being eliminated, because it supplied the product to those additional 50 individuals. In this instance price discrimination improves welfare, because more of a good is supplied in a situation where market valuation exceeds marginal cost.
perfect price discrimination or first-degree price discrimination: we could charge a different price to every consumer in a market, or for every unit sold, the revenue accruing to the monopolist would be the area under the demand curve up to the output sold.
second-degree price discrimination: offer different pricing options that buyers would choose from, with the result that her profit would be greater than under a uniform price.
third-degree price discrimination: two separable groups of customers and are very real.
Direct price discrimination: Charging customers based on their identity.
Indirect price discrimination: Offering a menu or set of prices and permitting customers to choose distinct prices.
< A monopoly seller would like to charge a higher markup over marginal cost to customers with less elastic demand than to customers with more elastic demand.
< In order for a seller to price discriminate, the seller must be able to identify (approximately) the demand of groups of customers, and prevent arbitrage.
< Since price discrimination requires charging one group a higher price than another, there is potentially an opportunity for arbitrage.
< Airlines commonly price discriminate, using “Saturday night stay overs” and other devices.
< Direct price discrimination is based upon the identity of the buyer, while indirect price discrimination involves several offers and achieves price discrimination through customer choices.
< Two common examples of indirect price discrimination are coupons and quantity discounts.
< If a price discriminating monopolist produces less than a nondiscriminating monopolist, then price discrimination reduces welfare.
< Price discrimination that opens a new, previously unserved market increases welfare.
< A ban on price discrimination tends to hurt the poor and benefit the rich, no matter what the overall effect.
< Two-part pricing involves a fixed charge and a marginal charge.
< The ideal two-part price is to charge marginal cost plus a fixed charge equal to the customer’s consumer surplus, in which case the seller captures the entire gains from trade.
In case of Monopoly, if we have a linear demand curve, the MR curve will also be linear with twice as much slope of the demand curve.
Causes of Monopoly:
- Natural Monopoly: An industry where a single firm can supply the market at a lower cost than 2 or more firms. Government gives a firm this status.
- Government Decisions, examples patents
- Control of a Natural Resource
In the graph above, the monopolist is in short term equilibrium because it is maximizing profit at MR=MC. It is also in long term equilibrium even though there is +ve profit because there it’s a monopoly. There is no way for other firms to enter this market.
Antitrust Laws – Sherman Act (1890)
- Price Fixing
Skill, Foresight, and Industry clause, rule of reason
Demand is elastic, when price goes up, total revenue TR goes down. When price goes down, TR goes up.
Demand is inelastic, when price goes up TR goes up. When price goes down, TR goes down.
When demand is linear in monopoly, MR is also linear twice as steep as Demand curve. TR is going up when MR is +ve, price is coming down, which means demand is elastic. TR is going down when MR is -ve, price is coming down, which means demand is inelastic.