BBA I Semester Managerial Economics Price Discrimination Under Monopoly Study Material Notes

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BBA I Semester Managerial Economics Price Discrimination Under MonopolyStudy Material Notes

BBA I Semester Managerial Economics Price Discrimination Under Monopoly Study Material Notes: Types of Price Discrimination Condition s for Price Discrimination Beneficial or Harmful to Society Its Benefits Exercise :

 Which Can Help You While Prepairing for All Semester Examination.
Which Can Help You While Preparing for All Semester Examination.

MCom I Semester Managerial Economics Trade Cycles or Business Cycles Study Material Notes

PRICE DISCRIMINATION UNDER MONOPOLY

MEANING

Price discrimination means charging different prices from different customers or for different units of the same product. In the words of Joan Robinson: “The act of selling the same article, produced under single control at different prices to different buyers is known as price discrimination.” Price discrimination is possible when the monopolist sells in different markets in such a way that it is not possible to transfer any unit of the commodity from the cheap market to the dearer market. Price discrimination is, however, not possible under perfect competition, even if the two markets could be kept separate. Since the market demand in each market is perfectly elastic, every seller would try to sell in that market in which he could get the highest price. Competition would make the price equal in both the markets. Thus price discrimination is possible only when markets are imperfect.

TYPES OF PRICE DISCRIMINATION

Price discrimination is of many types.

Firstly, it may be personalized based on the income of the customer. For example, doctors and lawyers charge different fees from different customers on the basis of their incomes. Higher fees are charged to rich persons and lower to the poor.

Secondly, price discrimination may be based on the nature of the product. Paperback is cheaper than the de-luxe edition of the same book, for the former is bought by the majority of readers, and the latter by libraries. Unbranded products, like open tea, are sold at lower prices than branded products like Brooke Bond or Lipton tea. Economy size tooth pastes are relatively cheaper than ordinary-sized tooth pastes. In the case of services too, such price discrimination is practised when off-season rates of hotels at hill stations are very low as compared to the peak season. Dry cleaning firms charge for two while they clean three clothes during off-season; whereas they charge more for quick service in peak reason.

Thirdly, price discrimination is also related to the age, sex and status of the customers. Barbers charge less for children’s hair-cuts. Certain cinema halls admit ladies only at lower rates. Military personnel in uniform are admitted at concessional rates in all cinema houses.

Fourthly, discrimination is also based on the time of service. Cinema houses at certain places, like New Delhi, charge half the rates in the morning show than in the afternoon shows.

Fifthly, there is geographical or local discrimination when a monopolist sells in one market at a higher price than in the other market. Lastly, discrimination may be based on the use of the product. Railways charge different rates for different compartments or for different services. Less is charged for the transportation of coal than for bales of cloth on the same route. State power boards charge low rates for industrial use than for domestic consumption of electricity.

CONDITIONS FOR PRICE DISCRIMINATION

For price discrimination to exist the following conditions must be satisfied:

(1) Market Imperfections. Price discrimination is possible when there is some degree of market imperfection. The individual seller is able to divide and keep his market into separate parts only if it is imperfect. Customers do not move readily from one market to the other because of ignorance or inertia.

(2) Agreement among Rival Sellers. Price discrimination also takes place when the seller of a commodity is a monopolist or when rivals enter into an agreement for the sale of the product at different prices to different customers. This is usually possible in the sale of direct services. A single surgeon may charge a high fee for an operation from a rich patient and relatively low fee from a poor patient. In place where a number of surgeons and physicians practise, they charge their fees according to the income of the patients. The rate of fee is fixed for each category of patient. Lawyers charge from their clients in proportion to the degree of risk or amount of money involved in a law suit. Price discrimination is possible in the case of services because there is no possibility of resale.

(3) Geographical or Tariff Barriers. Discrimination may occur on geographical grounds. The monopolist may discriminate between home and foreign buyers by selling at a lower price in the foreign market than in the domestic market. This type of discrimination is known as “dumping”. It can only be successful if the commodities sold abroad can be prevented from being returned to the home country by tariffrestrictions. Sometimes transport costs are so high that they act as a safeguard against the return of dumped goods. Geographical discrimination satisfies Pigou’s first condition for discrimination ‘when no unit of the commodity sold in one market can be transferred to another.’

(4) Differentiated Products. Discrimination is possible when buyers need the same service in connection with differentiated products. Railways charge different rates for the transport of coal and copper. For they know that it is physically impossible for a copper merchant to convert copper into coal for the purpose of transporting it cheaper. This satisfies Pigou’s second condition that ‘no unit of demand proper to one market can be transferred to another.’ It also applies to discrimination based on age, sex, status and income of buyers of services. For instance, a rich man cannot become poor for the sake of getting cheap medical facilities.

(5) Ignorance of Buyers. Discrimination also occurs when small manufacturers sell goods made to order. They charge different rates to different buyers depending upon the intensity of their demand for the product. Shoe makers charge a high price for the same variety from those customers who want them earlier than others. For the same variety of shoes, different buyers are also charged different prices because individual buyers are not in a position to know the price being charged to others.

(6) Artificial Differences between Goods. A monopolist may create artificial differences by presenting the same commodity in different quantities. He may present it under different names and labels, one for the rich and snobbish buyers and the other for the ordinary. Thus he may charge different prices for substantially the same product. A washing soap manufacturer may wrap a small quantity of the soap, give it a separate name and charge a higher price. He may sell it at Rs 17 per kg. as against Rs 16 for the unwrapped soap.

(7) Differences in Demand. For price discrimination, the demand in the separate markets must be considerably different. Different prices can be charged in separate markets based on differences of elasticity of demand. Low price is charged where demand is more elastic and high price in the market with the less elastic demand.

PRICE DISCRIMINATION

Price discrimination occurs when the monopolist divides the buyers of his commodity or service into two or more groups and charges a different price to each group. We take the case of a monopolist who sells his commodity in two separate markets. This analysis is based on the following conditions:

(1) The aim of the monopolist is to maximize his profits. He, therefore, produces that output at which his marginal revenue equals marginal cost. Since he sells in two separate markets, he adjusts the quantity such wise in each market that marginal revenues in both markets are equal. Given the marginal cost of producing the commodity, the most profitable monopoly output will be determined at a point where the combined marginal revenue of both the markets equals the marginal cost. Or, monopoly profit= MR, = MR, = MC. If the marginal revenue is greater in market one than in market two, the monopolist will sell less to market two and shift this quantity to market one. This will tend to raise the price in market two and lower in one, up to a point where marginal revenues in the two markets are equal.

(ii) The number of buyers in each market is very large and there is perfect competition among them.

(iii) There is no possibility of resale from one market to the other.

(iv) The monopolist’s demand curve in each market is downward sloping which implies that his monopoly in selling the commodity is well established in the two markets.

(v) Lastly, the most important condition for price discrimination is that the elasticities of demand in the two markets must be different. For price discrimination to be profitable the elasticities of demand for the monopoly product must be different in the two markets. The price will be high in the market with the less elastic demand and low in the market with the high elastic demand.

Figure 1 illustrates price and output determination under price discrimination. The monopolist sells his product in two markets, 1 and 2. Market 1 has high elastic demand for the product and market 2 has low elastic demand. Accordingly, the demand curve in market is D, and its corresponding marginal revenue curve is MR, and in market 2 the corresponding curves are D, and MR. Panel C in Figure 1 shows MR, the total marginal revenue curve drawn by the lateral summation of the MR, and MR, curves, and MC is the marginal cost curve. The point of intersection between the MR, and MC curves at E determines the equilibrium level of output 00. The monopolist divides this output between the two markets by equating the marginal cost Q E with the marginal revenue of each market.

Price Discrimination Under Monopoly

To equal the marginal cost Q, E with MR, and MR, draw a line EA parallel to the horizontal axis. It cuts MR, at E, and MR, at E, which become equilibrium points for the sale of output in each market. Thus, the quantity sold in market 1 is 0g, and in market 2 it is 09, so that 09, +0g, equal the total output oQ, The price QP, is less in the highly elastic market and price QP, is high in the less elastic market Q,P, Q,P.. Total profits earned by the discriminating monopolist are MEC, the difference between MR-MC (total marginal cost).

Price Discrimination Under Monopoly

Price Discrimination Beneficial or Harmful to Society

Price discrimination is beneficial or harmful to society under the following circumstances: Its Benefits

1 Profitable to the Monopolist. Price discrimination is profitable for the monopolist when elasticities of demand in the two markets are different. He charges a high price in the less elastic market and low price in the more elastic market. He will increase his profit by selling more in the more elastic market and less in the less elastic market.

2. More Production. When a monopolist sells his product at a low price in the market, his sales increase, he produces more and earns large profit.

3. Benefits to Society. If there were no discrimination, society would be deprived of the use of certain commodities and services. As Robinson said, “It may happen, that a railway would not be built, or a country doctor would not set up in practice.” The existence of railways depends upon their charging higher rates to some customers than to others in the same train and a doctor charges more fee from the rich than the poor patients.

4. Economic Welfare. Price discrimination helps in promoting economic welfare when governments provide cheap public utility services, such as telephone, telegraph, or rail transportation.

5. Reducing Inequalities. Price discrimination is also beneficial to society for it helps in reducing inequalities of personal incomes when higher prices or fees are charged to the rich than to the poor.

6. Through Dumping. Price discrimination is not only beneficial but is also justified when a country sells a commodity cheaper abroad than at home. It means expansion in output, the use of larger resources of the economy, more employment and income to the community.

Its Harms

1 Misallocation of Resources. Price discrimination is harmful to society because it! leads to maldistribution of resources controlled by the monopolist with the result that output, employment and income are not maximised.

2. Diversion of Resources. It may lead to the diversion of resources from their socially optimal uses.

3.Exploitation of People. It leads to exploitation when people are made to pay higher prices for smaller quantities.

4. Dumping harmful. Dumping is harmful when the price discrimination takes the form of dumping, the monopolist charges a high price from domestic consumers and low price from foreign consumers.

EXERCISES

1 What do you mean by discriminating monopoly? How is price determined under it?

2. What is price discrimination? Explain price-output determination under discriminating monopoly.

3. What is price discrimination? Under what conditions price discrimination is possible? Is price discrimination beneficial to society?

Price Discrimination Under Monopoly

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