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I. Ii. Iii.: ST ND RD

Economics - Lec 21

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Susheel Kumar
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14 views

I. Ii. Iii.: ST ND RD

Economics - Lec 21

Uploaded by

Susheel Kumar
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Introduction to Economics –ECO401 VU

Lesson 21
MARKET STRUCTURES (CONTINUED)

PRICE DISCRIMINATION (PD) happens when a producer charges different prices for the
same product to different customers. A seller with a degree of monopoly power has the ability
to price discriminate. This means being able to charge a different price to different customers.

TYPES OF PRICE DISCRIMINATION


PD can be of three types:
i. 1st degree PD
ii. 2nd degree PD
iii. 3rd degree PD
ST
1 DEGREE PD
In this type, everyone charged according to what he can pay. Seller can charge the highest
price of any product from customers. First-degree price discrimination occurs when identical
goods are sold at different prices to each individual consumer. Obviously, the seller is not
always going to be able to identify who is willing to pay more for certain items, but when he or
she can, his profit increases.
For example, this type of price discrimination can be observed in the sale of both new and
used cars. People will pay different prices for cars with identical features, and the salesperson
must attempt to estimate the maximum price at which the car can be sold. This type of price
discrimination often includes a bargaining aspect, where the consumer attempts to negotiate a
lower price.

2ND DEGREE PD
In this type, different prices charged to customers who purchase different quantities.
Examples of this can often be found in the hotel and airline industries where spare rooms and
seats are sold on a last minute standby basis. In these types of industry, the fixed costs of
production are high. At the same time the marginal or variable costs are small and predictable.
If there are unsold airline tickets or hotel rooms, it is often in the businesses best interest to
offload any spare capacity at a discount prices, always providing that the cheaper price that
adds to revenue at least covers the marginal cost of each unit.
In retail stores, second-degree price discrimination also exists. A reduced price may be offered
if you buy two t-shirts instead of just one. This form helps to get rid of merchandise and
generate more revenue for a company.

3RD DEGREE PD
In this type, seller charge different prices to different customers in different markets.
For example, exporters may charge a higher price in overseas markets if demand is
estimated to be more inelastic than it is in home markets. In Pakistan, there is food chain like
Mc Donald’s, pizza hut, KFC etc. They sell their products at different prices in different
countries. Moreover, senior citizens are considered a group, and are often offered discounts
at movie theaters, for transportation, in restaurants, and even in retail stores where seniors
may have a “senior day” each week that allows them to take a discount on merchandise.
“Students” are another segmented group that may be offered lower prices. Both seniors and
students have a higher elasticity of demand and can generally afford to pay less than the
average worker.
Consequences of PD:
PD can allow firms making losses to make profits, firms to increase their supernormal profits if
make supernormal profits; allow goods to be produced that would otherwise not be produced.

PRE-REQUISITES / CONDITIONS OF PRICE DISCRIMINATION


i. That markets should be independent (it should not be possible for the different
customers to arbitrage the price differences in the market).

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Introduction to Economics –ECO401 VU

ii. Firms should have the flexibility to price discriminate (i.e. should have some
control over prices, so perfect competition ruled out).
iii. Price elasticity of demand for different customers should be different.
BENEFITS OF PRICE DISCRIMINATION
Price discrimination can be both, beneficial or harmful for public interest depending on a
number of factors (equity or fairness concerns, the production of goods otherwise not
produced, the use to which price-discriminating firms put their supernormal profits to, etc.).
P

Gain after PD

P2 T
X
P1

Q2 Q1 Q
MONOPOLISTIC COMPETITION
Monopolistic competition is also characterized by a large number of buyers and sellers and
absence of entry barriers. In these two respects it is like perfect competition. Firms are price-
takers but not in the extreme sense of perfect competition. Products are differentiated and in
this respect, it is different from perfect competition.
Thus the characteristics of a monopolistically competitive market are almost the same as in
perfect competition, with the exception of heterogeneous products, and that monopolistic
competition involves a great deal of non-price competition (based on subtle product
differentiation). A firm making profits in the short run will break even in the long run because
demand will decrease and average total cost will increase. This means in the long run, a
monopolistically competitive firm will make zero economic profit. This gives the company a
certain amount of influence over the market; because of brand loyalty, it can raise its prices
without losing all of its customers. This means that an individual firm's demand curve is
downward sloping, in contrast to perfect competition, which has a perfectly elastic demand
schedule.

SHORT RUN AND LONG RUN UNDER MONOPOLISTIC COMPETITION:


In the short run, super normal profits are possible, but, in long run only normal profits can be
earned. Equilibrium obtains where the AR curve becomes tangent to the AC curve. Public
interest depends upon the position of AC at the point of tangency. If the AR curve is steep then
the point of tangency will produce an output that will be well to the left of right the point where
P= MC or P=AC minimum.
Since products are differentiated, there is room and rationale for advertising and product
promotion.

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Introduction to Economics –ECO401 VU

Monopolistic competition & public interest


LRMC
LRAC

L
P2 DL under perfect competition
K
P1

DL under monopolistic
competition

O Q2 Q1 Q

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