price discrimination price discrimination is the practice of selling different units of a good or...
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Price Discrimination
Price discrimination is the practice of selling different units of a good or service for different prices. To be able to price discriminate, a monopoly must: Identify and separate different buyer types Sell a product that cannot be resoldPrice differences that arise from cost differences are not price discrimination.
Price Discrimination
Price Discrimination and Consumer SurplusPrice discrimination converts consumer surplus into economic profit. A monopoly can discriminateAmong units of a good. Quantity discounts are an example. (But quantity discounts that reflect lower costs at higher volumes are not price discrimination.)Among groups of buyers. (Advance purchase and other restrictions on airline tickets are an example.)
Price Discrimination
Profiting by Price Discriminating
Figures 12.8 and 12.9 show the same market with a single price and price discrimination and show how price discrimination converts consumer surplus into economic profit.
Price Discrimination
As a single-price monopolist, this firm maximized profit by producing 8 units, where MR = MC and selling them for $1,200 each.
Price Discrimination
By price discriminating, the firm can increase its profit.
In doing so, it converts consumer surplus into economic profit.
Price Discrimination
Perfect Price Discrimination
Perfect price discrimination extracts the entire potential consumer surplus and converts it to economic profit.
Price Discrimination
With perfect price discrimination:
Output increases to the quantity at which price equals marginal cost.
Economic profit increases above that earned by a single-price monopoly.
Deadweight loss is eliminated.
Price Discrimination
Efficiency and Rent Seeking with Price DiscriminationThe more perfectly a monopoly can price discriminate, the closer its output gets to the competitive output (P = MC) and the more efficient is the outcome. But this outcome differs from the outcome of perfect competition in two ways: The monopoly captures the entire consumer surplus. The increase in economic profit attracts even more rent-seeking activity that leads to an inefficient use of resources.
Monopoly Policy Issues
Gains from MonopolyA single-price monopoly creates inefficiency and price discriminating monopoly captures consumer surplus and converts it into producer surplus and economic profit. And monopoly encourages rent-seeking, which wastes resources.But monopoly brings benefits.
Monopoly Policy Issues
Product innovationPatents and copyrights provide protection from competition and let the monopoly enjoy the profits stemming from innovation for a longer period of time.
Economies of scale and scopeWhere economies of scale or scope exist, a monopoly can produce at a lower average total cost than a large number of competitive firms could achieve.
Monopoly Policy Issues
Regulating Natural Monopoly
When demand and cost conditions create natural monopoly, government agencies regulate the monopoly.Figure 12.11 shows how a natural monopoly might be regulated.
Monopoly Policy Issues
With no regulation, the monopoly maximizes profit.It produces the quantity at which marginal revenue equals marginal cost.
Monopoly Policy Issues
Regulating a natural monopoly in the public interest sets output where MB = MC and the price equal to marginal cost.This regulation is the marginal cost pricing rule, and it results in an efficient use of resources.
Monopoly Policy Issues
With price equal to marginal cost, ATC exceeds price and the monopoly incurs an economic loss.If the monopoly receives a subsidy to cover its loss, taxes must be imposed on other economic activity, which create deadweight loss.
Monopoly Policy IssuesWhere possible, a regulated natural monopoly might be permitted to price discriminate to cover the loss from marginal cost pricing.Another alternative is to produce the quantity at which price equals average total cost and to set the price equal to average total cost—the average cost pricing rule.
