PRICE DISCRIMINATION UNDER MONOPOLY
Price discrimination refers to the charging of different prices by the monopolist for the same product.
The difference in the product may be on the basis of brand, wrapper etc. This policy of the monopolist is called price discrimination.
ACCORDING TO KOUTSOYIANNIS
“Price discrimination exists when the same product is sold at different prices to different buyers.”
ACCORDING TO STIGLER
“Price discrimination refers to the sale of technically similar products at prices which are not proportional to their marginal cost.”
ACCORDING TO ROBINSON
“Price discrimination is charging different prices for the same product or same price for the differentiated product.”
ACCORDING TO PROF. DOOLEY
“Discriminatory monopoly means charging different rates from different customers for the same good or service.”
ACCORDING TO J.S. BAINS
“Price discrimination refers strictly to the practice by a seller to charging different prices from different buyers for the same good.”
TYPES OF PRICE DISCRIMINATION
Price discrimination is a common pricing strategy’ used by a monopolist having discretionary pricing power. This strategy is practiced by the monopolist to gain market advantage or to capture market position.
There are three types of price discrimination which are as follows:
It refers to price discrimination when different prices are charged from different individuals. The different prices are charged according to the level of income of consumers as well as their willingness to purchase a product. For example, a doctor charges different fees from poor and rich patients.
It refers to price discrimination when the monopolist charges different prices at different places for the same product. This type of discrimination is also called dumping.
DISCRIMINATION ON THE BASIS OF USE
It occurs when different prices are charged according to the use of a product. For instance, an electricity supply board charges lower rates for domestic consumption of electricity and higher rates for commercial consumption.
DEGREES OF PRICE DISCRIMINATION
Price discrimination has become widespread in almost every market. In economic jargon, price discrimination is also called monopoly price discrimination or yield management. The degree of price discrimination varies in different markets.
FIRST-DEGREE PRICE DISCRIMINATION
The limit is defined in the concept of discrimination of the first degree, a concept introduced by A.C. Pigou. In discrimination of the first degree, the monopolist knows the maximum amount of money each consumer will pay for any quantity. He then fixes up prices accordingly and takes from each consumer the entire amount of his consumer’s surplus.
SECOND-DEGREE PRICE DISCRIMINATION
It refers to a price discrimination in which buyers are divided into different groups and different prices are charged from these groups depending upon what they are willing to pay. Railways and airlines practice this type of price discrimination.
THIRD-DEGREE PRICE DISCRIMINATION
It refers to a price discrimination in which the monopolist divides the entire market into submarkets and different prices are charged in each submarket. Therefore, third-degree price discrimination is also termed as market segmentation.
In this type of price discrimination, the monopolist is required to segment market in a manner, so that products sold in one market cannot be resold in another market. Moreover, he/she should identify the price elasticity of demand of different submarkets. The groups are divided according to age, sex, and location. For instance, railways charge lower fares from senior citizens. Students get discount in cinemas, museums, and historical monuments.
NECESSARY CONDITIONS FOR PRICE DISCRIMINATION
Price discrimination implies charging different prices for identical goods.
It is possible under the following conditions:
Existence of Monopoly:
This Implies that a supplier can discriminate prices only when there is monopoly. The degree of the price discrimination depends upon the degree of monopoly in the market.
This Implies that there must be two or more markets that can be easily separated for discriminating prices. The buyer of one market cannot move to another market and goods sold in one market cannot be resold in another market.
No Contact between Buyers:
This Refers to one of the most important conditions for price discrimination. A supplier can discriminate prices if there is no contact between buyers of different markets. If buyers in one market come to know that prices charged in another market are lower, they will prefer to buy it in other market and sell in own market. The monopolists should be able to separate markets and avoid reselling in these markets.
Different Elasticity of Demand:
This Implies that the elasticity of demand in the markets should differ from each other. In markets with high elasticity of demand, low price will be charged, whereas in markets with low elasticity of demand, high prices will be charged. Price discrimination fails in case of markets having same elasticity- of demand.
A monopolist practices price discrimination to gain profits. However, it acts as a loss for the consumers.
Following are some of the advantages of price discrimination:
- Helps organizations to earn revenue and stabilize the business
- Facilitates the expansion plans of organizations as more revenue is generated
- Benefits customers, such as senior citizens and students, by providing them discounts
Some of the disadvantages of price discrimination as follows:
i. Leads to losses as some consumers end up paying higher prices
ii. Involves administration costs for separating markets.
EQUILIBRIUM DETERMINATION UNDER DISCRIMINATING MONOPOLY
Equilibrium Conditions of a Discriminating Monopoly
If a discriminating monopolist is to be in equilibrium, two separate conditions have to be fulfilled.
(1) Marginal revenue in both (or all) markets must be the same:
When the elasticity of demand for a monopolist’s product is different in different markets, he would supply a smaller amount and charge a high price for the product where the demand is inelastic; but he would supply a larger amount and charge a low price for the same where the demand is elastic. By doing so, he will have to equalise the marginal revenue in both or all markets.
(2) The marginal revenue derived from each of these markets must also equal the marginal cost of the monopolist’s total output:
It means that the monopolist would supply the different amounts in A and B markets in such a way and up to that amount at which the marginal revenue from the sale in each of these markets must be equal to the monopolist’s marginal cost of producing the total output (aggregate of output in A and B).
In other words, the equilibrium condition of a discriminating monopolist becomes:
MR1 (marginal revenue in market A) = MR2 (marginal revenue in market B) = MC.
These two conditions are nothing more than an application of the general principle of equilibrium, i.e., MR = MC.
The equilibrium under discriminating monopoly can be shown in the following figure.
In Figure (a) and (b) show the average and marginal revenue curves of the firm for two separate markets (sub-market A and sub-market B). These markets have different elasticities of demand at each price. In Figure (c) the profit maximising output (OM) is shown at the intersection of the marginal cost curve (MC) for the monopolist’s whole output, with the curve showing combined marginal revenue (CMR) obtained from the two markets. The curve CMR is obtained by adding the curves MR1 and MR2 together sideways.
In this equilibrium situation, the output is OM, and marginal revenue is OL or MR. The output OM has, therefore, to be distributed between the two separate markets in such a way that marginal revenue in each is OL. It means that OM’ is to be sold in sub-market A at price OP (marginal revenue is here OL).
Similarly, OM” must be sold in sub-market B at a price of OP” (marginal revenue here is also OL). The monopolist’s profit is shown by the area ARB in Figure (c) and here it is at a maximum.
Output under Price Discrimination:
The total output of a monopolist with two or more prices can be either larger or smaller than his total output if he would sell at one price. Conceivably, too, a monopolist could have an output equal to the output corresponding to conditions of pure competition.
In practice, demand and cost relations can be such that without discrimination a particular commodity or service will not be produced at all. Take the case of India’s sugar industry. If free sale of sugar is prohibited production of sugar will be unprofitable.
Some commodities and services might not be produced at all if sellers were not be able or were not allowed to practice price discrimination. The standard and simple example is the physician in a small village. Similarly, railroad service on a particular route might depend on the ability of the railroad to charge higher rates to some groups of commuters than to others.