Question

Explain the effect of price discrimination on consumer surplus and economic profit

Answer 1

In Price Discrimination firms are trying to get buyers to pay a price as close as possible to their maximum willingness to pay.In this way a firm can capture consumer surplus and transform it into producer surplus. By price discriminating, the firm can increase its profit. In doing so, it converts consumer surplus into economic profit.

Consumer Surplus and Economic Profit in Perfect Price Discrimination

• In Perfect price discrimination: a firm sells each unit of Q for the highest P anyone is willing to pay.
• Under Perfect Price Discrimination Consumer Surplus is Zero.
• The profit-maximizing output increases to the quantity at which P (= MR) equals MC.
• Economic profit increases above that made by a single-price monopoly.
• Deadweight loss is eliminated - but it and all the consumer surplus is transferred to the producer.

Monopoly and Effect of Price Discrimination on Consumer Surplus and Economic Profit.

The more perfectly a monopoly can price discriminate, the closer Q is to the competitive output (P = MC) and the more efficient is the outcome.But this outcome differs from the outcome of perfect competition in two ways:

• The monopoly captures the entire consumer surplus.
• The increase in economic profit attracts even more rent-seeking activity that leads to inefficiency.