Question

Please explain the the characteristics and welfare effects of

a) first-degree price discrimination.

b) third-degree price discrimination.

Answer 1

a) Price discrimination of the first degree occurs when the monopolist charges a different price for each unit of the commodity sold. The monopolist charges the maximum that each buyer is able to and willing to pay, leaving him no consumer surplus. Obviously this involves the maximum exploitation of the buyers. A hospital charging higher price from rich and lower price from the poor for an operation is an example of first degree price discrimination.

b) Third degree price discrimination occurs when the monopolist charge different price for the same product by dividing the market into different segments or by dividing the consumers into different groups. For example a monopolist may issue a movies ticket at different rates to minor, adult and senior citizens.

Both first and third degree price discrimination have similar welfare effects. The poor families have lower income and thus they are unable to pay normal market price. Thus price discrimination allows them to pay lower price than usually paid by the rich people. This will improve the standard of living of the poor as they have access to a variety of goods at lower price.

The first and third degree price discrimination enables the firms to receive a larger profit. As the price charged by the monopolist is higher than marginal cost, a greater profit is received through these types of price discrimination. This may create dynamic efficiency under monopoly.

Under the practice of price discrimination, the allocation is inefficient. Most of the consumers expected to pay a price above the marginal cost. Thus the price discrimination is harmful to the majority of poor.

Under price discrimination the higher income groups may pay a lower price or the lower income groups may pay a higher price. This will create negative effect on economic welfare.

The price discrimination compels the monopolist to produce at the lowest point of the average total cost. Thus there will be no spare capacity left under discriminating monopoly. Thus products are available at lower cost and it leads to the maximization of social welfare.

The price discrimination gives more profit to the monopolists and enables them to grow and get greater market share. This will create barriers to the entry of other firms. This will limit the consumer choice and welfare.

The price discrimination leaves zero consumer surpluses since the monopolist charge a price equal to the maximum willingness to pay by the consumers. Thus the consumers get no welfare under price discrimination.