Equilibrium Price and Output Determination under Discriminating Monopoly

Meaning of Price Discrimination

Price discrimination refers to the situation when a producer sells the same product to different buyers (or at different sub-markets) at different prices. The seller divides the buyers into two or more than two sub-markets and charges different prices in these sub-markets. This is the most common form of price discrimination. Buyers are discriminated in respect of prices on the basis of their income or purchasing power, geographical location, age, sex, quantity they purchase, their association with the sellers, frequency of visits to the shop, the purpose of the use of the commodity or service and on other grounds which the seller may find suitable. These factors give rise to demand curves with different elasticities in the various sectors of the market of a firm. It is also common to charge different prices for the same product at different time periods. Price discrimination is mainly adopted to achieve three goals. They are:

1. Profit maximization
2. Promotion of public welfare
3. Provision of incentive to less developed economic sector

Some examples of price discrimination

a. Doctors are able to separate patients with high income from those with low income and charge a higher fee from the former.
b. Some countries dump goods at low prices in the foreign market to capture them.
c. Railway or air services charge different prices to different grades of seats like business class and economy class.
d. Nepal Electricity Authority charges a higher price to the household sector than the industrial sector.

Economic effects of price discrimination

The following are the major economic effects of price discrimination:

1. According to Mrs. Joan Robinson, total output under price discrimination tends to be larger that the output under a simple monopoly with a uniform price policy.
2. Total profits of the discriminating monopolist will be higher than that of the simple monopolist. It is because the price discrimination at least partially helps the monopolist in converting the consumer’s surplus into a profit.
3. Price discrimination helps increase the sales and the output, as such, larger scale of production and minimization of costs.
4. Socially justified price discrimination under which the poor buyers are charged lower prices helps in improving the economic welfare of the community at large.
5. In a widening market, in the case of dumping, the exporting firm can reap the advantage of the economies of large in the case of dumping, the exporting firm can reap the advantage of the economies of large-scale plant size in operation.
6. Price discrimination of the first and second degrees obstructs the maximization of utility.
7. Price discrimination leads to inefficient allocation of resources in a market economy.
8. Price discrimination can also be inequitable when the richer consumers are benefited at the cost of the poor.

Conditions for price discrimination

The necessary conditions which must be fulfilled for the implementation of price discrimination are the following.

1. The seller should have some control over the supply of his product, i.e. monopoly power in some firms is necessary to discriminate price.
2. The market must be divided into sub-markets with different price elasticities.
3. There must be effective segmentation of sub-markets so that no reselling can take place from a low price market to a high price market. If those who buy in the low price segment of the market can easily resell in the high price segment, the resulting decline in supply would increase price in the low price segment and the increase in supply would lower the price in the high price segment. The price discrimination policy would thereby be undermined.

Degrees of Price Discrimination

Professor A.C. Pigou, an English economist, created the idea of degrees of price discrimination. Pigou speaks of the following three degrees of price discrimination.

Price and output under first-degree discrimination

In discrimination of the first degree, the monopolist knows the maximum amount of money each consumer will pay for any quantity. He will set the prices accordingly and take from each consumer the entire amount of consumer’s surplus. In other words, in the first degree of price discrimination, the price charged by the monopolist will be different for every individual unit of a homogeneous commodity. The monopolist tries to charge the highest price for each consumer that he will be ready to pay for each unit rather than go without.