Price Discrimination

MONOPOLY - PRICE DISCRIMINATION
• Price discrimination is a process where a seller can charge different prices to

different buyers for the same commodity. This practice is done by a monopolist, as the
seller/firm is a price maker in a monopoly market.
• Prof. A. C. Pigou has classified price discrimination into three categories -
i) First degree price discrimination
ii) Second degree price discrimination
iii) Third degree price discrimination
i) First degree price discrimination:
• Under first degree price discrimination, the monopolist can sale each separate unit of
output at different prices.
• Here every buyer has to pay the maximum price which he is willing to pay.
• First degree price discrimination also known as “perfect price discrimination” and “take
it or leave it” price discrimination”.
• Perfectly price discriminating monopolist must produce at an output level where P =
MC. In case of figure-1, it will be at the level of output QM. In the cases of P > MC, the
monopolist will always try to produce more as it will increase his profits. Thus
equilibrium will be reached where P=MC.
• In this case there will be no consumer surplus. Producer surplus will be the entire (A+B)
region.
• Example: A doctor charging his patients different prices based on their ability to pay.
Figure 1: First degree price discrimination
1
ii) Second degree price discrimination:
• Second degree price discrimination is also known as block pricing.

• In this form of price discrimination price per unit of output depends on how much the
consumer is buying.
• The buyers are divided into different groups. From each group lowest demand is
charged.
• With respect to figure-2, DD’ is the demand curve. For OQ1 amount of output price
charged by the monopolist is P1. For Q1Q2 amount of output P2 price will be charged and
similarly for Q2Q3 amount of output P3 price will be charged.
• The shaded regions B1, B2, B3 and B4 represents consumer surplus.
• Example: For making STD calls a company charges a higher rate for the first 5 minutes
and then call rate gets reduced.
Figure-2: Second degree price discrimination
2
iii) Third degree price discrimination:
• It is the most common form of price discrimination.

• It occurs when the monopolist is able to divide the market into two groups according to
the variation in elasticity.
• Example: Students discounts at movies, senior citizens’ discount at the medicine store
etc.
• Suppose, the monopolist divides the market into two segments M1 and M2. Let, e1 and
e2 be the elasticities of M1 and M2 segments respectively, such that, e1 > e2.
• In this case, the monopolist’s equilibrium will be where MR1=MR2 .
• Since, e1 > e2
 1/e1 < 1/e2
 (1-1/e1) > (1-1/e2) …………………….(i)
Now, MR1= P1 (1-1/e1) and MR2= P2 (1-1/e2)
At equilibrium,
MR1 = MR2
 P1 (1-1/e1) = P2 (1-1/e2) since, MR = P (1- 1/e)

 P1/P2 = (1-1/e2)/( 1-1/e1)
 P1/P2 < 1 [Since, (1-1/e2) < (1-1/e1) from equation (i)]
 P1 < P 2
 If e1 > e2 then P1 < P2
Therefore, the monopolist will charge higher price in the market where e p is low and he will
charge lower price where ep is high.
3
Conditions of Price Discrimination:
We have to keep in mind that price discrimination is possible only under the following
circumstances.
• Different price elasticities of demand: The monopolist will charge higher price in the
market where price elasticity is relatively inelastic and he will charge lower price
where price elasticity is relatively elastic.
• Tariff barrier: If in a country tariffs are imposed on the imported goods, the
monopolist can sell his products in the domestic market at a higher price and at a
lower price in the foreign market. This happens because the imposed tariff on the
imported goods makes the foreign goods relatively costlier.
• Geographical distance between the markets: If two markets are separated from
one another by geographical distance, the monopolist can sell his products at a
higher price in the local market and at a lower price in the distant market. Since it
will be unprofitable for the local buyers to purchase the goods from the distant
market at a lower rate because of huge transportation cost.
• Impossibility to resale a product: It applies to the cases of the doctors/lawyers

charging different payments for their service from different clients according to their
ability to pay.
• Behavior of the consumers: If the consumers are ignorant of the differences of

prices of the same product in two different markets or if they do not pay any
importance to small differences in price of the same product, price discrimination
becomes easy to the monopolist.

Price Discrimination

Uploaded by

Copyright:

Available Formats

Price Discrimination

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Price Discrimination

Uploaded by

Copyright:

Available Formats

MONOPOLY - PRICE DISCRIMINATION

• Price discrimination is a process where a seller can charge different prices to

i) First degree price discrimination:

Figure 1: First degree price discrimination

• Second degree price discrimination is also known as block pricing.

Figure-2: Second degree price discrimination

• It is the most common form of price discrimination.

Now, MR1= P1 (1-1/e1) and MR2= P2 (1-1/e2)

 P1 (1-1/e1) = P2 (1-1/e2) since, MR = P (1- 1/e)

• Impossibility to resale a product: It applies to the cases of the doctors/lawyers

• Behavior of the consumers: If the consumers are ignorant of the differences of

You might also like