PRICE DISCRIMINATION PDF note

 

PRICE DISCRIMINATION

Price discrimination exists when the same product is sold at different prices to different buyers. The cost of production may be same or it differs but not as much as the difference in the charged prices.  The product is basically the same but it may have little difference like different editions of the same book, high price & low-price edition, different locations of seats in a cinema hall, different seats in an aircraft or in a train etc.

A typical case is about identical products, produced at same cost but sold at different prices depending on the preference of the buyers, their income, their location & the availability of substitutes. For these differences the demand curves will be of different slopes in the different sectors of the firm. It is also common to charge different prices for the same product at different time periods- a new product is often sold at  a high price only to the rich, while subsequently it is sold at lower prices to the  low income groups.

Although price discrimination is more easily implemented by a monopolist because he controls the whole supply of a given commodity, this price policy is quite commonly followed by most firms which charge a different price to their customers depending on the items they purchase, relationship between sellers & customers & other factors.

The necessary conditions which must be fulfilled for the implementation of price discrimination are the following.

1.     The market must be divided into sub markets with different price elasticities.

2.     There must be effective separation of the sub markets so that no reselling can take place from the low price market to the high price market. This condition shows why price discrimination is easier to apply with commodities like electricity or gas or services of a doctor or lawyer which are consumed by the buyer & can’t be resold.

Price discrimination is possible under the following conditions.

1.     The nature of the commodity: The nature of the commodity or service may be such that there is no possibility of transferring the commodity from one market to another like the services of doctors or lawyers.

2.     Existence of Monopoly: Discrimination is possible only if monopoly exists & there is no competition in the market.

3.     Division of market: The market is distinctly divisible into different parts among which products can’t be exchanged.

4.    Preference or Prejudices of buyers: Sometimes price discrimination is possible when the same product is sold to different groups of people with different packaging. Also, it is not be possible for the buyers in the dearer market to transfer themselves into the cheaper market to buy the goods or services at a lower price.

5.     Long distance or tariff barriers: Price discrimination often occurs when the markets are separated by large distance or tariff barriers.

6.     Legal Sanction: In some cases, there may be legal sanction for price discrimination like electricity or railways.

7.     Ignorance & Laziness of the buyers: Price discrimination is possible due to ignorance and laziness of the buyers.

8.     Different purpose: It may be possible when several groups of buyers require the same service for clearly differentiated commodities. For example, the railways charge different rates of fares for the transport of coal & cotton. Price discrimination is not possible under perfect competition. It can occur under imperfect market conditions. The degree of price discrimination depends on the degree of imperfection of the market.

Prof. A.C.Pigou has distinguished between the following three types of price discrimination based on the degree of exploitation.

1.     Price discrimination of the first degree: Iit occurs when the monopolist is able to sell each separate unit at different price. So each buyer is forced to pay the price which he is willing to pay. The seller leaves no consumer surplus with any buyer.

2.     Price discrimination of the second degree: It occurs if a monopolist can divide the buyers into different groups & from each group he charges a different price which is the lowest demand price of the group.

3.     Price discrimination of the third degree: It occurs when the seller divides his buyers into two or more than two sub markets or groups depending on the price elasticity of demand & charges a different price in each sub market. The price charged depends on the output sold in the submarket & the demand conditions of the sub market. This is most common. A common example is when a seller sells at a higher price in the domestic market & lower price in the international market.

Price discrimination is profitable when elasticities of demand in the submarkets are different. If at a single monopoly price the elasticities in the two submarkets are different then MR will be different in the two markets. The market with higher elasticity will have a higher MR & a market with lower elasticity will have a lower MR. so, it is profitable for the monopolist to transfer some commodities from low elasticity market to high elasticity market. This way the MR will increase in the low elasticity market & MR in the high elasticity market will fall. Ultimately the MR of both the market will be equal & it will not be profitable any more to transfer goods from one market to another. So, the equilibrium will be reached.

So the equilibrium conditions are:-

1.     Aggregate MR= MC of the total product

2.     MR_a  = MR_b = MC

The last question is whether price discrimination is socially justified or not. A discriminating monopoly is sometimes thought to be socially unjustified. But there are many public services which would not be available to the poor if there were no discrimination. When doctors charge more from the rich and less from the poor then both the rich & poor people will be satisfied & the doctor will get enough income so that they can continue to see the poor people at lower prices. The same logic is applied for public utility services. However, when private monopolists discriminate between consumers & extract the whole consumer’s surplus to increase profits, this is not socially justified.

Thus to pass judgement on the social desirability of a particular case of price discrimination, all these have to be considered.