Question

ANALYSIS QUESTION

Does the firm make more profits if it engages in 1st or 2nd -degree price discrimination? Explain with numerical graphical examples. The more detailed the explanation you provide, the more credits you’ll get.

Answer 1

Price discrimination is a practice which involves the firms charging different prices for similar goods and services to different consumers based on their maximum willingness to pay. In this way, by charging prices equal to their maximum willingness to pay, the firm captures part of consumer surplus, thereby increasing its profits at the expense of consumers.

A firm makes more profit in 1st degree price discrimination as compared to second degree price discrimination. First degree price discrimination is also known as perfect price discrimination. In such type of price discrimination, a firm charges a different price for every unit of output consumed. This way the firm captures the entire consumer surplus of consumers.

However, in a second degree price discrimination a seller divides the consumers into groups based on their willingness to pay. In this way, the seller takes over parts of consumer surplus for some of the consumers and the entire surplus for other consumers. This is unlike 1st degree price discrimination where the seller takes away the entire surplus for each consumer.

The figure a in the above image attached displays 1st degree price discrimination. Since, each consumer is charges the maximum amount he/she is willing to pay, the entire shaded area goes to the producers.

However, in figure b corresponding to 2nd degree price discrimination, the consumers are divided in groups. for example, if persons having maximum willingness to pay between price P and P1 might be charged P1. Hence, only the shaded portions in figure b go to consumers. Rest of it goes to producers. Hence, in first degree price discrimination there is no consumer surplus. However, some consumer surplus still exist in second degree price discrimination.