Price Discrimination and also its Effects on Efficiency inMonopolistic Markets (econclassroom14:51)http://www.econclassroom.com/?p=3118

Outline:

Define price discrimination Three conditions crucial for price discrimination Three forms (degrees) of price discrimination The effect of perfect price discrimicountry on effectiveness (graph)

Definition: Price discrimination occurs once a firm through marketpower charges various prices to consumers for an identicalproduct.

You are watching: A perfectly price-discriminating monopolist is able to

ME: Keep in mind that the word "discrimination" does not intend that this is a bad point. All "discrimination" implies is that various customers are treated in a different way, i.e. they pay different prices. We will uncover out that price discrimination might actually be GOOD for culture.

Examples:

Movie theaters: Charge various prices based on age. Seniors and also youth pay less considering that they tfinish to be even more price sensitive. Gas stations: Gas stations will certainly charge different prices in various neighborhoods based on relative demand also and place. Quantity discounts: Grocery stores offer discounts for bulk purchases by customers that are price sensitive (think “buy one gallon of milk, obtain a second gallon free”… the family of 6 is price sensitive and is most likely to pay much less per gallon than the dual revenue couple through no kids who would certainly never before buy 2 gallons of milk). Hotel room rates: Some hotels will charge much less for customers that bother to ask about one-of-a-kind room rates than to those that don’t also bvarious other to ask. Telephone plans: Some customers who ask their provider for unique rates will certainly discover it exceptionally easy to get much better calling prices than if they don’t bother to ask. Airline ticket prices: Weekend stayover discounts for leicertain travelers suppose organization civilization, whose demand also for flights is very inelastic, yet who will hardly ever remain over a weekfinish, pay much even more for a round-expedition ticket that departs and also retransforms during the week.

Three conditions important for price discrimicountry to occur:

firm have to have actually industry power (therefore purely competitive firms cannot price discriminate, but monopolies can firm need to have the ability to segregate customers through different willingnesses to pay which implies through different price elasticities of demand ME: those with a less elastic demand are charged a greater price. So what happens to complete revenue (TR)? We know that if demand is inelastic and price goes up, TR boost. those with elastic demand are charged a reduced price. So what happens to TR? We recognize that if demand is elastic and price goes dvery own, TR boost. Our textbook specifies price discrimination as "the selling of a product to different buyers at various prices once the price differences are not justified by distinctions in cost.
so charging more for a vehicle in Alaska and also less for one in Detroit because it prices more to ship the vehicle to Alaska is NOT price discrimicountry But, because we assume that the costs (TC) are the same, the result of price discrimicountry is better TR with the same TC, So, HIGHER PROFITS buyers are prevented from remarketing the product to someone else

Example: Airline tickets

ME: airlines have market power which means that they can set their own price

ME: service travelers have actually a much less elastic demand curve than vacation travelers, however how have the right to the airline recognize if a ticket buyer is a organization traveler or a vacation traveler? One way is to call for a Saturday night continue to be for customers buying round-pilgrimage tickets. Business travelers like to be residence on weekends and vacation travelers tend to want to be on vacation over the weekend

resale is prevented because your name is on the ticket and you have to have a equivalent ID

Three kinds (degrees) of price discrimination

third Degree: where consumers are split into GROUPS. For instance, age teams through different price elasticities (movies tickets are cheaper for kids and more expensive for adults), or time of purchase (civilization that buy beforehand pay less than those who buy at the last moment).

2nd Degree: where price discrimicountry is based on the amount purchased. For instance, buying in mass (huge quantities) is cheaper than buying small quantities or two-for one (or buy 2 obtain one free). the more you buy the less you pay per unit

first Degree: Also called "Perfect Price Discrimination". This is wright here each individual customer pays a different price, each customer pays the highest price that he or she is willing to pay based upon their demand also. This means tright here will certainly be no consumer excess yet many producer surplus.

The Effect of Perfect Price Discrimicountry on Efficiency (graphshowing third level price discrimination)

REVIEW: Graph of a "single-price" monopolist maximizing profit. "Single-price" means that tright here is no price discrimination
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So, if this monopolist did not price discriminate they would produce amount Qm and charge price Pm. (They will develop the amount wbelow MR=MC.) ME: and at Qm, P > MC so the monopolist is not allocatively effective.

PRICE DISCRIMINATION: But notice that the demand also curve goes above Pm, meaning that tright here are customers willing to pay even more than Pm. What would occur if the monopolist could charge these customers more given that they are willing to pay more? What happens is: if the monopolist can charge each customer the highest possible price that they are willing to pay, then MR will certainly be the exact same as price (or demand).

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D = MR or P = MR

So, what amount will certainly the perfectly price discriminating monopolist produce to maximize profits? This is always wbelow MC=MR. Almethods.

On the graph, if P = MR then MR = MC wright here P = MC. You should remember that this is the formula offered to uncover allocative performance (the socially optimal quantity)

Results of perfect price discrimination:

more will be created than a single-price monopolist (Qp=MC on the graph below) some consumers will certainly pay greater prices than they would certainly if tright here was no price discrimination (Pm), but other consumers will certainly pay reduced prices profits will certainly be greater (the blue plus the yellow areas on the graph below) AND MOST IMPORTANTLY the perfectly price discriminating monopolist will certainly create the allocatively effective quantity!

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Conclusion:

1st degree price discrimination is practically difficult and therefore exceptionally unwidespread. second and also third degree price discrimination are more prevalent however, second and 3rd level price discrimicountry execute not achieve the same increase in output as perfect price discrimination and therefore execute not accomplish the exact same level of allocative effectiveness, but they are still better than a single-price monopolist. effects: even more is created consumer excess is moved to the producers in the develop of greater revenues and revenues Is price discrimicountry great for society? it depends: YES - it is much better for the monopolist bereason they acquire better earnings YES - it does boost allocative performance NO - if you are among the customers who hregarding pay an even better price YES - if you are among the customers that gets the product at a lower price, and if tbelow were no price discrimination, you would not gain the product at all

Natural Monopoly and also the require for Government Regulationhttp://www.econclassroom.com/?p=3115

What is a "Natural Monopoly"?

Monopoly wbelow the lengthy run ATC curve has economic situations of scale over an extremely huge variety of output You deserve to determine the graph of a herbal monopoly bereason the demand also (D) curve crosses the ATC curve as soon as the ATC is still downward sloping this indicates that one very big firm deserve to develop eextremely thing that is demanded AT AT LOWER AVERAGE COST than if there were numerous contending firms Examples: giving water to houses in a city electrical utilities herbal gas If tbelow were many providers each serving only a few customers the ATC (costs per unit of output) would certainly be greater it would certainly make even more sense to have actually just one company carry out the product bereason then the costs per unit (ATC) would certainly be reduced. That is why this is dubbed a "natural" monopoly. this is bereason tright here are extremely high solved expenses (TFC). Think of all the prices of running water pipes to every house in a city. These are all resolved costs. And since the TFC are exceptionally exceptionally high, then the TC will be very high, and also the just method to acquire ATC to be low is to have actually a huge amount of output (Q) ATC = TC / Q if TC are very high bereason of incredibly high TFC then: ATC is high if: ATC = high TC / low Q but, ATC would certainly be low if : ATC = high TC / huge Q

Compare graphs:

graph of a continual monopoly graph of a herbal monopoly (EoS - Economies of Scale)

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So, Society is better off (reduced costs) if only one firm producesthe product, BUT:

what will a profit maximizing monopolist perform is such a case? they would develop the profit maximizing quantity, wright here MR = MC and this is NOT the allocatively efficient quantity prefer other monopolists, a herbal monopolist will certainly charge a greater price (Pm) and create a lower quantity (Qpm) than the socially optimum (alloc. eff.) price of Pso and amount of Qso Result: allocative inefficiency; an underalarea of resources ME: so WHAT WE GET (Qpm) is less than WHAT WE WANT (Qso)

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To really benefit culture, organic monopolies need to be regulatedby the government

This means that the government have to use price controls and subsidies to accomplish allocative effectiveness, Qso But what price have to the government select? if the federal government puts on a price ceiling at the allocatively effective price of Pso the monopolist would then develop the allocatively reliable quantity of Qso bereason the ceiling price becomes the firm"s MR and also then MR = MC at Qso BUT, we have the right to see that at Qso the ceiling price is much less than the ATC and the monopoly would be earning losses equal to the blue rectangle on the graph below in the long run, businesses cannot operate at a loss and they will certainly go out of business. This would certainly not be excellent for culture.

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What have the right to the government carry out to proccasion herbal monopolies from going out of organization bereason to the price ceiling? they deserve to usage BOTH a price ceiling AND a subsidy to assist the monopoly create the socially optimum quantity. ME: our textbook does NOT use the subsidy graph displayed in the video lecture (view below)

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ME: our textbook claims that there are two options to the difficulty of natural monopolies earning a loss at the allocatively efficient price: carry out a subsidy to cover their losses yet this might be politically unrenowned. Would you assistance better taxes to give money to Commonwealth Edison electrical company? the other solution that is provided a lot in the unified states is AC pricing, where the federal government does not set a price ceiling at the allocatively reliable price (Pso), however quite they put the price ceiling at a pclimb wbelow D=ATC (wright here the demand also curve crosses the ATC curve).

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If the price is Pac then the firm will certainly create Qac is the allocative efficient? NO, but it is closer to Qso will certainly the firms earn earnings or losses? They will earn normal revenues (profits = zero) and also they will certainly be able to stay in company. (Remember: economic expenses encompass the explicit expenses AND the implicit price which indicates that investors are earning a rerevolve on their investment approximately equal to their following ideal different.)