Question

Suppose demand for a firm’s product – this firm has market power - is made up of demand from two groups of consumers with different elasticities of demand – one relatively elastic and the other relatively inelastic. The firm has chosen to charge simple linear (per-unit) prices. Under what conditions will the firm be able to charge different prices to the different consumer groups? Assuming those conditions hold, which group will face the higher price? Why? Show your answer graphically, and explain your answer carefully. Use graphical analysis when appropriate.

Answer 1

In case the monopoly charges a single price, it will be equating marginal revenue from its aggregate demand function with its marginal cost and this will determine the quantity it will be selling cumulatively to the two groups. Then the corresponding prices can be found using the respective demand functions.Using this price, the corresponding quantities are computed

For price discrimination, certain conditions are required that will enable the firm to charge different prices to the different consumer groups. The first condition is that it must be able to segregate the two groups, by identifying which is the elastic demand and which is inelastic. It must prevent resale in two markets. Higher price is faced by the consumer group that has inelastic demand and lower price is faced by the group that has elastic demand.