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Price Discrimination refers to charging different prices for the same item
based on individual customer characteristics and quantity. Under certain
conditions, a monopolist can increase its profits by charging different
prices to different buyers. In doing so, the monopolist engages in price
discrimination. This practice allows the monopolist to maximize its profits
by capturing consumer surplus.
Price discrimination is possible for a monopolist because it has significant
market power and no competition
Price discrimination is a pricing strategy where a seller charges different
prices to different groups of consumers for the same product or service.
To successfully implement price discrimination, certain conditions or
prerequisites must be met.
When the following conditions exist, price discrimination may occur:
1. Monopoly Power: The seller must be a monopolist or, at least,
own some degree of monopoly, that is, some ability to control
output and price.
2. Market discrimination: The seller must be able to separate
buyers into distinct classes, each with a different willingness or
ability to pay for the product.
3. Price discrimination must be profitable: Price differentiation
leads to an increase in the seller's overall profit compared to
charging the same price to all customers. In other words, the additional
revenue generated by charging different prices to different segments
should compensate for any additional costs or difficulties related by
implementing a differentiation strategy. This division of purchasers is
typically based on various levels of demand elasticity.
4. No resale: The original purchaser cannot resell the product or service.
If buyers in the low-price segment of the market can easily resell in the
high-price segment, the monopolist's price discrimination strategy will
create competition in the high-price segment. This competition will
lower the price in the high value segment and challenge the monopolist's
price discrimination policy.
5. No Regulatory or legal barrier: There should be no legal or not
Regulatory barriers that prohibit or limit price discrimination in the
relevant market. In some cases, competition laws may limit the extent
to which price discrimination may occur.
6. Cost Differentiation: The seller must have some flexibility in terms
of cost structure or productivity. This allows the seller to offer lower
prices to certainsegments without experiencing a loss. For example,
it may be possible to offer a discount to students if the cost of their
service is lower due to lower marketing or distribution costs.
Consequences of Price Discrimination:
A monopolist can increase its profit by practicing price discrimination.
At the same time, perfect discrimination results in greater output than
occurring with a single monopoly price.
erent prices to different customer segments based on their willingness
to pay. This means that the business can charge higher prices to
customers who are willing to paymore and lower prices to those who
are more price sensitive. As a result,the business can capture a larger
portion of the consumer surplus, maximizing its total revenue. By
charging higher prices to customers with a higher willingness to pay, a
business can improve its profit margins. This is parti-cularly beneficial
for businesses with significant market power, such as monopolies or
firms in oligopolistic markets. Price discrimination allows a business
to tailor its pricing to different market segments. This means that it can
charge premium prices to customers who value the product or service
more, while still attracting price-sensitive customers with lower prices.
This targeted approach can lead to higher profits.
2. More Production: Other things being equal, the discriminating mono-
polist will choose to produce more output than the non-discriminating
monopolist.Remember that when an indiscriminate monopolist lowers
its price to sell additional output, the lower price applies not only to the
additional output but also to all previous units of output.
As a result, marginal revenue is less than price and, graphically, the marginal
revenue curve lies below the demand curve. The fact that marginal revenue
is less than price acts as a disincentive to increase output.
But when a perfectly differentiated monopolist lowers price, the lower price
applies only to the additional unit sold and not to the earlier units. Therefore,
price and marginal revenue for each unit of output are equal. The marginal
revenue curve for a perfectly differentiated monopolist coincides with the
demand curve, so the disincentive to increase output is removed.
Graphical Approach:
(a) The single-price monopolist produces output Q1 at which MR=MC,
charges price P1 for all units, incurs an average total cost of A1, and
realizes an economic profit represented by area vcft.
(b) The perfectly discriminating monopolist has MR=D and, as a result,
produces output Q2, where MR=MC. It then charges the maximum price
for each unit of output, incurs average total cost A2, and realizes an eco-
nomic profit represented by area zaer.
Types of Price Discrimination:
1st degree captures the whole consumer surplus.
First-degree price discrimination, also known as perfect price discrimination,
is the most advanced and idealized form of price discrimination. In this
pricing strategy, a seller charges everyone the maximum price they are
willing to pay for a product or service. Basically, sellers capture the entire
customer surplus, which is the difference between what the customer is
willing to pay (their reservation price) and what they actually pay.
Example: Auction (high willingness to pay will drive up the price)
- It is efficient that haram
- some consumers.
In a pricing technique known as first-degree price discrimination, a business
charges every client the highest price they will accept for a good or service.
This means that the firm captures all of the consumer surplus, resulting in
higher profits for the firm. In this type of discrimination, there is no dead-
weight loss and the firm gains both allocative and production efficiency.
- It eliminates deadweight loss.
- It maximizes the overall surplus.
First-degree price discrimination does not necessarily harm consumers in the
sense of reducing their welfare. However, this can be seen as less fair or just
because each consumer pays a price based on their individual willingness.
This means that some customers may pay higher prices than in a competitive
market or other pricing strategies.
Second-Degree (Nonlinear) Price Discrimination:
The cost of the second degree varies depending on the unit.
Second-degree price differentiation, also known as nonlinear price different-
iation, is a pricing strategy in which a firm differentiates between different
groups of customers based on their characteristics, behavior, or purchasing
patterns. Receives prices. Unlike first-degree (perfect) price discrimination,
where each consumer pays an individual price, second-degree price
discrimination groups consumers and offers them different price options
within those groups. This type of price discrimination can be seen in
different industries and markets.
In 2nd degree producer charge different prices for different quantities or
- Buying in bulk: Quantity discounts; a single light bulb might be priced
at $5, while a box containing four of the same bulb might be priced at
$14, making the average price per bulb $3.50.
- Block pricing: The practice of charging different prices for different
Example: Electric power companies charge different prices for a consumer
purchasing a set block of electricity.
Third Degree (Group) Price Discrimination:
3rd degree based on some characteristics is used to divide the consumer
group. The third degree of price discrimination, also known as group price
discrimination, occurs when a firm charges different prices to different
groups of consumers based on different characteristics. This form of price
differentiation is based on demographic, geographic, or other market-based
criteria rather than individual characteristics. The objective is to maximize
the firm's profits by pull out more consumer surplus from different market
segments.
Firms classify consumers into different groups based on observable
characteristics, such as age, income, location, student status, membership
in a particular organization, or other relevant demographics. Each group is
offered a uniquepricing structure. This may include lower prices for one
group and higher prices for another, depending on the price elasticity of
demand for each group.
Example: Many businesses, such as movie theaters, restaurants, and
software companies, offer discounts to students who can provide a valid
student ID. Low prices are intended to attract price-sensitive student
customers. Airlines often charge different prices for the same flight based
on the point of departure, because they recognize that consumers in
different regions may have different price sensitivities.
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