Price Discrimination
Draw the graph for a monopoly with demand, marginal revenue, and marginal cost curves. Identify the profit-maximizing output level (Qm) and price (Pm).
Suppose the monopolist sells Qm units of output at the regular price and then puts the product on sale at a lower price, Ps. Show the new price and quantity. Identify the consumer surplus of the additional sales. What happens to the firm’s profits? Does price discrimination lead to a more efficient or less efficient outcome? Why or why not?
ANSWER
Monopoly and price discrimination
A monopoly is a type of market where there is one firm or a single seller but many buyers. In such a case, the seller has absolute control over the market and hence can determine and fix the price of goods and services (Aguirre et al., 2010). The demand and the marginal revenue curves are downward sloping. However, the marginal curve is steeper. The graph below represents monopoly market with marginal revenue, demand as well as the marginal cost curves. Besides, the graph illustrates the profit maximizing output and price.
Figure 1: Profit maximizing output and price for a monopoly market.
The equilibrium profit-maximization condition is Marginal revenue is equal to marginal cost. Hence C stated in the figure represents the equilibrium.
Graph with new price and quantity
Figure 2: New price and quantity
When a lower price Ps is charged, the quantity demanded will increase from Qm to Q s as indicated in figure 2, such that the new quantity and price becomes Q s and Ps respectively. At a lower price more quantity can be sold (Aguirre et al., 2010). The consumer surplus will increase due to decrease in price while the firm’s profits will decrease. The consumer surplus is represented by triangle
(a Ps b). Price discrimination enhances the efficiency because it leads to fairness.
Reference
Aguirre, I., Cowan, S., & Vickers, J. (2010). Monopoly price discrimination and demand curvature. American Economic Review, 100(4), 1601-15.
