Price Discrimination under Monopoly and Necessary Condition

8th February 2020 0 By indiafreenotes

Price discrimination is a selling strategy that charges customers different prices for the same product or service, based on what the seller thinks they can get the customer to agree to. In pure price discrimination, the seller charges each customer the maximum price he or she will pay. In more common forms of price discrimination, the seller places customers in groups based on certain attributes and charges each group a different price.

Price discrimination is most valuable when the profit that is earned as a result of separating the markets is greater than the profit that is earned as a result of keeping the markets combined. Whether price discrimination works and for how long the various groups are willing to pay different prices for the same product depends on the relative elasticities of demand in the sub-markets. Consumers in a relatively inelastic submarket pay a higher price, while those in a relatively elastic sub-market pay a lower price.

[Important: Price discrimination charges customers different prices for the same products based on a bias toward groups of people with certain characteristics—such as educators versus the general public, domestic users versus international users, or adults versus senior citizens.]

With price discrimination, the company looking to make the sales identifies different market segments, such as domestic and industrial users, with different price elasticities. Markets must be kept separate by time, physical distance, and nature of use.

For example, Microsoft Office Schools edition is available for a lower price to educational institutions than to other users. The markets cannot overlap so that consumers who purchase at a lower price in the elastic sub-market could resell at a higher price in the inelastic sub-market. The company must also have monopoly power to make price discrimination more effective.

Price Discrimination under Monopoly

In monopoly, there is a single seller of a product called monopolist. The monopolist has control over pricing, demand, and supply decisions, thus, sets prices in a way, so that maximum profit can be earned.

The monopolist often charges different prices from different consumers for the same product. This practice of charging different prices for identical product is called price discrimination.

According to Robinson, “Price discrimination is charging different prices for the same product or same price for the differentiated product.”

According to Stigler, “Price discrimination is the sale of various products at prices which are not proportional to their marginal costs.

In the words of 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.”

Necessary Conditions for Price Discrimination

Price discrimination implies charging different prices for identical goods.

It is possible under the following conditions:

(i) Existence of Monopoly

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.

(ii) Separate Market

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.

(iii) No Contact between Buyers

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.

(iv) Different Elasticity of Demand

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.

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.

  1. Personal

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.

  1. Geographical

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.

  1. On the basis of use

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.

Conditions for Price Discrimination

Price discrimination is possible under the following conditions:

  • The seller must have some control over the supply of his product. Such monopoly power is necessary to discriminate the price.
  • The seller should be able to divide the market into at least two sub-markets (or more).
  • The price-elasticity of the product must be different in different markets. Therefore, the monopolist can set a high price for those buyers whose price-elasticity of demand for the product is less than 1. In simple words, even if the seller increases the price, such buyers do not reduce the purchase volume.
  • Buyers from the low-priced market should not be able to sell the product to buyers from the high-priced market.

Hence, we can conclude that a monopolist who employs price discrimination, charges a higher price from the market with inelastic demand. On the other hand, the market which is more responsive is charged less.

Difference between price discrimination and product differentiation

  • Charging different prices for similar goods is not pure price discrimination
  • Product differentiation gives a supplier greater control over price and the potential to charge consumers a premium price arising from differences in the quality or performance of a product