Price Discrimination
 Definitions
 Price discrimination: the business practice of selling the same good at different prices to
different customers, even though the costs for producing for the two customers are the same
 Single-price monopolist: a monopolist who charges everyone the same price
 Market power: the ability of a single economic actor (or small group of actors) to have a
substantial influence on market prices
 Deadweight loss: the fall in total surplus that results from a market distortion
 Explanation
 Price discrimination is a rational strategy for a
profit-maximizing monopolist. That is, by charging
different prices to different customers, a monopolist
can increase its profit.
 Certain market forces can prevent firms from price
discriminating
 Ex. Arbitrage – the process of buying a good in
one market at a low price and selling it in
another market at a higher price to profit from
the price difference
 Price discrimination can raise economic welfare
 Conditions
 A firm must have some market power
 Price discrimination can occur in monopolies, oligopolies, and monopolistic competition, but
not perfect competition
 Price discrimination requires the ability to separate customers according to their willingness to
pay
 Perfect Price Discrimination
 When the monopolist knows exactly each customer’s
willingness to pay and charges each customer that
price; consumer values the good at more than the
marginal cost
 The monopolist gets the entire surplus in every
transaction in the form of profit
 No deadweight loss occurs (no inefficiency)
 In general, the greater the number of different prices
charged, the closer the monopolist is to perfect price
discrimination
 In reality, price discrimination is not perfect
Examples: Movie tickets, airline prices, discount coupons, financial aid, quantity discounts
 Deadweight Loss – The Inefficiency of Monopoly
 The socially efficient quantity is found where
the demand curve and the marginal-cost curve
intersect
 When a monopolist charges a price above marginal
cost, some potential consumers value the good
more than MC, but less than the monopolist price.
They do not buy the good. The result is inefficient.
 Monopoly pricing prevents some mutually
beneficial trades from taking place
 The socially efficient quantity of output occurs
when the marginal cost curve intersects with the
demand curve (MC = D)
 The monopolist produces less than the socially
efficient quantity of output
 The inefficiency of monopoly can be measured with
a deadweight loss triangle
Monopolistic Competition
 Characteristics of a monopolistic competition
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There are large number of sellers in the market
Firms sell slightly differentiated products
Since they sell slightly differentiated products firms have some price setting power
There is a very low entry barrier to market
The firms cannot make economic profit in the long run
Allocative and productively inefficient
 Short run
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In the short run the graph looks similar to a monopoly market
Demand is a downward sloping line since the firms have price setting power
Marginal revenue is below demand curve, it slopes down twice as steeply as the demand
curve
Firms make economic profit
 Long run
 In the long run demand and marginal revenue decreases and flattens out more.
 This is caused by the low entry barrier to the market
 Other firms join into the market when they see economic profit is being made
 In the long run graph the new demand curve is tangent to the ATC curve
 This shows the firms are no longer making economic profit
 They are breaking even
 If firms start experiencing economic loss, they can easily leave the market, and firms will
return to breaking even
 Efficiency
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Firms are productively inefficient
They are not producing at a quantity where average total cost is lowest
Firms are allocatively inefficient
The demand curve (marginal benefit) is not equal to marginal cost