Business Economics Assignment: Impact Of Price Discrimination On Profit Of A Monopolist

Question

Task: Your task is to conduct a critical research and prepare a business economics assignment addressing how does price discrimination affect the profits that can be earned by a monopolist What effect does such discrimination have on economic welfare Use examples of cases of price discrimination to show how firms might exploit the existence of distinct markets for their product.

Answer

Answer:
Impact of Price Discrimination on Profit of a Monopolist:
As stated herein business economics assignment, in a monopoly market, the monopolist is the only seller who sells particular product or service to a large number of buyers. In this market, entry of new firms is not easy and hence substitute products are not available. Therefore, customers purchase the product instead of its higher price. This situation helps the monopolist to charge different price for the same product and it is called price discrimination. The monopolist is known as the price maker who can charge higher price for its products to make profit. The monopolist faces inelastic demand curve for which he can increase profit by a large extend by charging higher price. In this context, it is essential to mention that profit of the monopolist can be declined by practicing price discrimination if the demand curve is elastic in nature. In this situation, the seller can maximise profit by charging price at its profit maximising level. The monopolist tries to maximise profit by lowering its quantity of output to maintain the profit maximising output where marginal revenue and marginal cost become equal. The monopolist either can increase product price by restricting quantity of output sold or can increase the sales of product by decreasing the product price. However, in the latter condition, the seller will not get higher revenue. To maximise profit, the monopolist needs to set price according to the demand for products in the market and this situation in turn can maximise profits of the seller in the market.

In price discrimination, the monopolist can setvarious prices from various customers for a particular product. In this practice, the monopolistic firm can influence customers to purchase larger quantities of their good or service. Price discrimination also allows companies to attract uninterested consumers to purchase the particular product or service and to increase profit (Fabra and Reguant 2020). Price discrimination is of different types, which a monopolist can practice to gain profit. These are first-degree price discrimination, second-degree price discrimination and third-degree price discrimination. By applying first-degree price discrimination strategy, the monopolist can impose different prices for different unit of a product (Azzolina et al. 2021). The second-degree price discrimination allows the seller to make different prices for a product depending on the quantity of the product sold (Poort and Zuiderveen Borgesius 2019). This implies that the monopolist can sell products by offering quantity discounts. In third- degree price discrimination, the monopolist imposes different prices to different customer groups for a particular product (Poort and Zuiderveen Borgesius 2019). This strategy allows the seller to attract uninterested customers from different groups.

Figure 1: (a) First-Degree Price Discrimination (b) Second-Degree Price Discrimination (c) Third-Degree Price Discrimination

Figure 1 represents first-degree, second-degree and third-degree price discriminations, which indicate that the process can help a monopolist to charge different prices in different ways. Here, the monopolist can set various prices of a particular product for different classes of customers depending on their various elasticity of demand for it. In this context, it is essential to mention that the seller does not have different costs for giving the product to different customers. Inelastic demand helps the seller to charge higher price and to maximise profit instead of selling lower quantity. By recognising different market segments, the monopolist can charge different prices for its product accordingly considering different demand elasticities.

Impact of Price Discrimination on Economic Welfare:
In a monopoly market, price discrimination is used to maximise profit until the point where marginal revenue is higher than the marginal cost. Hence, the higher profit which is obtained by price discrimination can be applied to maximise dynamic efficiency. According to Bonatti and Cisternas (2020), the practice of price discrimination declines welfare of the economy if total output declines. On the contrary, price discrimination may have positive impact on economic welfare if it increases output and that can be beneficial for society. Monopoly firm applies price discrimination strategy to make the maximum revenue possible from every customer. This leads the seller to gain more of the total surplus by charging prices to consumers closer to their maximum willingness to pay. It is observed that price discrimination leads a firm to sell product at a higher output. This influences the firm to become more efficient in producing product. The increasing output helps the firm to gain greater profit by lowering long-run average costs. Different price discrimination strategy acts differently on consumer surplus. For instance, the second-degree price discrimination does not eliminate consumer surplus completely. However, it allows the firm to increase profit margin a subgroup of its customer base. On the other side, third-degree price discrimination declines consumer surplus by catering to the price elasticity of demand regarding certain subset of consumers.

From the study of Simshauser (2018), it is understood that price discrimination becomes harmful to society when it cannot distribute resources efficiently and consequently the economy cannot maximise output, income and employment. The condition of price discrimination generates wastes of resources when customers are forced to pay higher prices for lesser quantities of products. However, price discrimination also allows people to purchase product by demanding a lower price to them having elastic demand and higher prices to product having lower elasticities. This can help the firm to increase both profit and economic welfare by capturing the consumer surplus of those who have lower elasticity. Price discrimination can also increase economic welfare if the practice allows a product to be supplied in the economy.

Price discrimination of public utility service like rail, transportation etc is helpful for the government. In this process, higher income group people are forced to pay higher prices while the collected funds are used as subsidy for providing goods to the poor. Moreover, price discrimination also becomes beneficial to the society for decreasing inequalities of personal incomes. Higher prices are charged for public utility services to customers having higher income. This practice reduces income inequality by distributing it and consequently it promotes social welfare. Thus, price discrimination can be beneficial if the country sells products at a cheaper rate at home and higher rate at abroad. This will help the economy to earn foreign capital and consequently it will increase national income.

Thus, from the discussion, it can be said that price discrimination can increase economic welfare of a society if it is used to maximise economic efficiency, consumer surplus and distribution of income.

Examples of cases of price discrimination:
By using price discrimination strategy, an organisation can sell product in different market segments with various price elasticities. Price discrimination allows firms to exploit the existence of distinct markets for their product considering different demand elasticities of the same product. Price discrimination is practised at the time of selling movie tickets. Movie theatres charge different prices for customers of different age groups, such as, adults, children, seniors etc. Moreover, the ticket price also varies depending on the time of the show of a day. The pharmaceutical companies also follow price discrimination in the international market by charging different prices for drugs in different countries. These companies charge higher prices for drugs in rich countries compared to that in poor nations. The airline industry also practices price discrimination by selling travel tickets with different prices in different markets. Flight ticket of an airline varies depending on the destination, the time, day etc. The airline company can charge different prices for a single airline or airlines (Aryal, Murry and Williams 2018). Hence, customers search for the best price as per their requirements. Airline companies practice second-degree price discrimination by providing vouchers, discounts and member cards.

Firms practice price discrimination of different strategies to customers for same products. It is seen that companies provide coupons to its reserved customers who are price sensitive. Moreover, age discounts are also provided to customers where product price depends on the age of the buyer. For instance, children under specific age are received free education or free meals in different countries. Age discounts are also provided to restaurants, movies and other places of entertainment. However, the situation sometimes exploits consumers due to inelasticity. In transportation industry, the airline company charges high price for tickets during peak times compared to that in off-peak. In this condition, customers are forced to pay higher prices. Moreover, companies also offer discounts for new customers while old and loyal customers pay higher prices of products. From the above examples it is seen that firms can exploit the existence of distinct markets for their products. Consumers do not get their surplus benefit as they pay higher prices for products.

References:
Aryal, G., Murry, C. and Williams, J.W., 2018. Price discrimination in international airline markets. Available at SSRN 3288276. Azzolina, S., Razza, M., Sartiano, K. and Weitschek, E., 2021. Price Discrimination in the Online Airline Market: An Empirical Study. Journal of Theoretical and Applied Electronic Commerce Research, 16(6), pp.2282-2303.
Bonatti, A. and Cisternas, G., 2020. Consumer scores and price discrimination. The Review of Economic Studies, 87(2), pp.750-791. Fabra, N. and Reguant, M., 2020. A model of search with price discrimination. Business economics assignmentEuropean Economic Review, 129, p.103571.
Poort, J. and Zuiderveen Borgesius, F.J., 2019. Does everyone have a price Understanding people's attitude towards online and offline price discrimination. Internet Policy Review, 8(1), pp.1-20.
Poort, J. and Zuiderveen Borgesius, F.J., 2019. Does everyone have a price Understanding people's attitude towards online and offline price discrimination. Internet Policy Review, 8(1), pp.1-20.
Simshauser, P., 2018. Price discrimination and the modes of failure in deregulated retail electricity markets. Energy Economics, 75, pp.54-70.