Question

1. If a firm has two groups of customers whose elasticities of demand are different, how does it determine what prices to charge each group?

a. Sets the price (P) equal to marginal revenue (MR) equal to marginal cost (MC) in each market.

b. Sets the MR in each market equal to the firm’s MC and sets the price for each group by finding the prices on each group’s demand curve above where MR=MC.

c. Sets MC equal to P in each market.

d. None of the above.

Answer 1

1. b. Sets the MR in each market equal to the firm’s MC and sets the price for each group by finding the prices on each group’s demand curve above where MR=MC.

The limit is defined in the concept of discrimination of the first degree, a concept introduced by A.C. Pigou. In discrimination of the first degree, the monopolist knows the maximum amount of money each consumer will pay for any quantity. He then fixes up prices accordingly and takes from each consumer the entire amount of his consumer’s surplus.

This type of situation occurs when the monopolist sells each unit of his product at a different price. This means that he changes the maximum price a consumer is ready to pay for each unit, i.e., as much as the traffic will bear. This type of situation is illustrated in Fig.1. Mrs. Joan Robinson calls this phenomenon perfect discrimination, which is perfect, however, only from the point of view of the monopolist.

The simplest kind of discrimination of the first degree is one where, for some reason, each of his customers buy only one unit from the monopolist. When consumers buy more than one unit of the monopolist’s product, they are willing to buy more units at lower prices. The monopolist must then adjust his units of sale.

A discriminating monopolist reaches equilibrium and hence maximises profit when he equates the marginal revenue(s) in-both the markets, i.e., MR1 = MR2. If this condition holds total revenue will be maximum and revenue maximisation subject to cost constraint implies profit maximisation. So, we may calculate total revenue from each market for different price-quantity combinations and then the corresponding MR.