Question

PART D features an essay-type question and requires the student to provide a thorough discussion of the following specific issues asked.

2. Demonstrate that in order to achieve optimal third – degree price discrimination, marginal revenue for each consumer group must be equal to marginal cost;

3. By using the condition in subpart 2, demonstrate how the firm carrying out the third – degree price discrimination, should change its prices and total output if the demand curve for one consumer group shifts outward, causing marginal revenue for that group to increase.

Answer 1

Price discrimination is the process of charging different prices to different consumers for similiar goods.

There are three different types of proce discrimination- first degree, second degree and the third degree.

The third degree is the practice of dividing consumers into two or more groups with separate demand curves and charging different prices to each group.It is one of the most common forms of price discrimination and examples are the different airline charges, discounts to students and senior citizens. Some charateristics is used to divide the consumers into distinct groups. For example the spending capacity of the students and the senior cotozens are less in comparision to the rest of the poplulation and a college ID or driver's liscence is readily available to establish an identity.

Hence, once it is decided that the third degree price discrimination is feasible, the next step is what is the price to be charged from each group of consumers.

Whatever total amount is produced the total output should be divided between the groups of customers so that the marginal revenue for each group is equal. If this is not done, then the firm cannot maximize its profits. Lets say that there are two groups of customers A and B, and the marginal revenue from group A is more than group B, then the firm will gain by shifting output from the group B to group A. It woulld do this by lowering the price to the first group and raising the price to the second group. Thus, whatever the two prices, they must be such that the marginal revenues for the different groups are equal.

The total output must be such that the marginal revenue for reac group of consumers is equal to the marginal cost of productiion. Inorder to get to this level the firm will keep on adjusting its output and prices. For example, suppose the marginal revenues were same for each group of consumers but that marginal revenue exceeded marginal cost, the firm can defintely adjust its output and increase its total output and thereby increase its profit.It would lower its prices to both groups of consumers, so that the marginal revenue for each group would fall( but wouls still be equal to each other) and would approach marginal cost.

Consumers are divided into two groups, with separate demand curves for each group. The optimal prrices and quantities are such that the marginal revenue from each group is the same to the marginal cost. Hence group 1 with demand curve D1, is charged P1 and group 2 with more elastic demand curve D2 is charged a lower price P2.

Marginal cost depends on the total quantity produced QT. Note that Q1 and Q2 are chosen as the output for the respective groups so that MR1= MR2=MC.