Question

Explain what price discrimination is and the conditions necessary for a firm to be able to price discriminate. Provide an example. Why might the WA government decide to adopt a marginal cost pricing strategy in the monopolies that it is responsible for? What would be the advantages of such an approach?

Answer 1

Price discrimination is a kind of selling strategy that involves a firm selling a good or service to different buyers at two or more different prices, for reasons not necessarily associated with cost. Price discrimination results in greater revenue for the firm. For example, hotel rooms, airline tickets, and professional services all offer different prices for different customers.

Price discrimination is possible under the following conditions:

1. The seller must have some control over the supply of his product. Such monopoly power is necessary to discriminate the price.
2. The seller should be able to divide the market into at least two sub-markets (or more).
3. The price-elasticity of the product must be different in different markets. Therefore, the monopolist can set a high price for those buyers whose price-elasticity of demand for the product is less than 1. In simple words, even if the seller increases the price, such buyers do not reduce the purchase volume.
4. Buyers from the low-priced market should not be able to sell the product to buyers from the high-priced market. The WA government might introduce the marginal cost pricing policy to regulate the prices in the market and increase the output level.To promote a more efficient outcome, government can regulate natural monopolies.

1. Marginal Cost Pricing Rule

     A marginal cost pricing rule is a price rule for a natural monopoly that sets price equal to marginal cost. This rule leads to an efficient use of resources, but the monopoly incurs an economic loss. This rule is rarely used because of the negative effects on profit.

Advanatages of Marginal Pricing include

1. More efficient use of Resources

2. Lower prices

3. More output

4. Increase in consumer welfare