­­­­­Price discrimination under Monopoly: Discrimination of the first degree, second degree, third degree, dumping

­­­­­Price discrimination under Monopoly

Price discrimination means selling the same or slightly differentiated product to different sections of consumers at different prices without corresponding differences in cost. Consumers are discriminated on the basis of their purchasing power, geographical location, age, quantity purchased etc.

According to Mrs. Joan Robinson, “Price discrimination is the act of selling the same article produced under single control at a different price to the different buyers.”

According to Dooley “Discriminating monopoly means charging different rates from different customers for the same good or service.”

Thus, when a firm charges from two different consumers different prices for the same good, the firm is practicing price discrimination. An important aspect of price discrimination is that the marginal cost of the two goods must be the same.

Examples of price discriminations are:

• Doctors, lawyers, consultants, etc., charge their customers at difference rates mostly on the basis of their ability to pay.
• Merchandise sellers sell goods to relatives, friends, old customers, etc., at lower prices than to others.
• Railways and airlines charge lower fares from the children and students, and for different class of travelers.
• Different rates for cinema show, and musical concerts, etc.,
• Different prices in domestic and foreign markets.
• Higher electricity rates for commercial use and lower rates for domestic consumptions, etc.

Kinds of price discrimination:

There are three kinds of price discrimination:

1.    Discrimination of the first degree- In this case, the monopolist will not allow any consumer’s surplus to the consumer. He charges the maximum that each buyer is able and willing to pay, leaving him no consumer’s surplus. He charges a different price for each unit of the commodity sold. Thus, this involves maximum exploitation of the buyers. This is known as perfect price discrimination. A doctor or a lawyer guess the paying capacity of his patient or client and can charge the highest possible fee according to that.

2.    Discrimination of the second degree- Price discrimination of the second degree would occur when a monopolist is able to charge separate prices for different blocks or quantities of a commodity from buyers and in this way, he takes away a part, but not all of consumer surplus from them.

Thus, a monopolist charges a different price for different quantities consumed, such as quantity discounts on bulk purchases.

In the above diagram, a monopolist charges the highest price OP1 for OQ1 units, lower price OP2 for the next Q1Q2 units and the lowest price OP3 for the next Q2Q3 units. Thus, by adopting a block pricing system, monopolist maximizes his revenue at

TR=[OP1AQ1] +[OP2BQ2] +[OP3CQ3]

3.    Discrimination of the third degree- Price discrimination of the third degree is said to occur when the seller divides his buyers into two or more than two sub-markets or groups depending on the demand conditions in each sub-market and charges a different price in each sub-market. The price charged in each sub-market depends upon the output sold in that sub-market and the demand conditions of that sub-market. Price discrimination of the third degree is most common. A common example of such discrimination is found in the practice of a manufacturer who sells his product at a higher price at home and at a lower price abroad. Another example of the third-degree price discrimination is when an electric company sells electric power at a lower price to the households and at a higher price to the manufacturers who use it for industrial purposes.

Conditions:

• The aim of the monopolist is to maximize his profits. He, therefore, produces that output at which his marginal revenue equals marginal cost. Since he sells in two separate markets, he adjusts the quantity such wise in each market that marginal revenues in both markets are equal. Given the marginal cost of producing the commodity, the most profitable monopoly output will be determined at a point where the combined marginal revenue of both the markets equals the marginal cost. [MR1=MR2=MC].
• There is no possibility of resale from one market to the other.
• The monopolist's demand curve in each market is downward sloping.
• Lastly, the most important condition for price discrimination is that the elasticities of demand in the two markets must be different. 

Suppose that a monopolist has only two markets, market A and market B. Prices to be charged by the monopolist under price discrimination depend upon elasticity of demand for the products in different markets. The total output to be produced and supplied depends on marginal revenue and marginal cost. The principle of equilibrium under price discrimination is that marginal revenues in different markets are equal to marginal cost of the total output.

MR1= MR2= MC of the total output.

Suppose, in the sub-market A, the demand for the product is inelastic and in the sub-market B, relatively more elastic.

From the above diagram, it is clear that in the sub-Market A, the demand for the product is inelastic and hence a relatively higher price is charged P1 and on the equilibrium point E1, output Q1 is sold.

In the sub-Market B, the demand for the product is relatively more elastic, hence, relatively lower price is charged P2 and on the equilibrium point E2, output Q2 is sold.

The third diagram represents the total market for the product of monopolist.  MR and AR are the aggregate marginal revenue and aggregate average revenue in both the markets. MC is the marginal cost curve. At E point, MR=MC, the equilibrium position of the monopoly firm. The total output sold in the two sub-markets is represented by OQ.

Thus, it clearly shows that the monopolist has discriminated the two markets and charged different prices in these two markets.

                                                 Dumping

Dumping  takes place when a monopolist sells a portion of his output in a foreign market at a very low price and the remaining output at a high price in the home market. The home market is controlled and the foreign market is free or open. Foreign market in which he faces perfect competition, while in the home market, he has a monopoly. The demand curve for the product will be perfectly elastic for him in the foreign market while the demand curve will be sloping downward in the home market. 

Forms of Dumping:

• Persistent Dumping - When a monopolist continuously sells a portion of his commodity at a high price in the domestic market and the remaining output at a low price in the foreign market, it is called persistent dumping. The elasticity of demand is usually higher in the foreign market because there is severe competition among countries to sell their products in the foreign markets and also a relatively larger number of substitutes are available there. Thus, the monopolist maximizes profits by charging higher price in the domestic market and lower price in the international market.

• Predatory Dumping -It is the 'temporary' sale of a product at a lower price in the foreign market in order to drive foreign producers out of business, after which prices are raised there to take advantage of the newly acquired monopoly power. It represents unfair method of competition because under it a producer deliberately sells his product in a foreign country at a lower price (even below his cost of production) in order to eliminate competitors and gain control of the foreign market for a short period of time. When the producer gains monopoly control of the foreign market, he then exploits the foreign buyers by substantially raising the price of his product and thus maximizing his long-run profits. This type of dumping  is severely criticized and opposed.

• Sporadic Dumping - When the producer sells the unsold stocks at a low price in the foreign market without reducing the domestic price, it is called sporadic dumping.

Objectives of Dumping:

• ·      To Find a Place in the Foreign Market.
• ·      To Sell Surplus Commodity.
• ·      Expansion of Industry.

As in discriminating monopoly, output will be determined by the equality of the total marginal revenue curve and the marginal cost curve of producing the commodity.

The foreign market demand curve faced by the monopolist is the horizontal line PDF which is also the MR and AR curve because the foreign market is assumed to be perfectly elastic. The demand curve in the home market with a less elastic demand for the product is the downward sloping curve DH which is ARH curve and its corresponding marginal revenue curve is MRH. The lateral summation of the two MR curves leads to the formation of TREDF, as the combined marginal revenue curve. In order to determine the quantity of the product to be produced by the monopolist, we take the marginal cost curve MC. E is the equilibrium point where the MC equals the combined marginal revenue TREDF. OF output will thus be produced for sale in the two markets. Now, EF being the marginal cost, equilibrium in the home market will be established at R where marginal cost equals marginal revenue. OH, quantity will be sold at HM price and the remaining quantity HF will be sold in the foreign market at OP price. The total output OF is to be distributed between the home market and the foreign market in such a way that marginal revenue in each market is equal to each other and to the marginal cost EF. Thus, the monopolist sells more in the foreign market with the elastic demand at a low price and less in the home market with the less elastic demand at a high price. His total profits are TREC, If due to competition in the foreign market, price falls below OP, less will be produced than before. F will move to the left. On the other hand, in case of a rise in the open-market price above OP, the monopolist will produce more in order to gain more. Rise in the foreign-market price will be beneficial to the dumper so long as it does not affect adversely the demand for his product.  In case the price of the exported commodity falls below S, the monopolist will stop selling abroad.

WHEN IS PRICE DISCRIMINATION POSSIBLE?

Price discrimination is possible in the following cases:

1. The Nature of the Commodity. The nature of the commodity or service may be such that there is no possibility to transfer it from one market to the other. A surgeon or lawyer are the example of it. The surgeons usually charge different fees from the rich and the poor for the same kind of operation.  These services have to be delivered personally by the surgeon and therefore, it cannot be transferred.

2. Long Distances or Tariff Barriers. Discrimination often occurs when the markets are separated by long distances or tariff barriers so that it is very expensive to transfer goods from a cheaper market to be resold in the dearer market.

If a seller is selling his good in two different markets, say, in a home market and in a foreign market. He can raise the price of his product in the home market and sell the product in the foreign market at a lower price than at home. This practice of selling the product at cheaper rates abroad than at home is often known as ‘dumping’.

3. Legal Sanction. In some case there may be legal sanction for price discrimination.

For example, an electricity company sells electricity at a lower price for domestic purposes and at a higher price for commercial purposes.

Railways charge different fares for travelling in First Class, and Second-Class compartments.

4. Preferences or Prejudices of the Buyers. Price discrimination may become possible due to preferences or prejudices of the buyers.

Different prices are charged for different varieties, although they differ only in name or label. For example, open tea is sold at lower prices than branded tea. In this way the producers are usually able

to break up their market and sell the superior varieties to the rich people at higher prices and inferior varieties to the poor people at lower prices.

In Robinson’s words, “Various brands of a certain article which in fact are almost exactly alike may be sold as different qualities under names and labels which induce rich and snobbish buyers to divide themselves from poor buyers, and in this way the market is split up and the monopolist can sell what is substantially the same thing at several prices.”

5. Ignorance of Buyers. If a seller is discriminating between two markets but the buyers of the dearer market are quite ignorant of that fact that the seller is selling the product at a lower price in another market, then price discrimination by the seller will persist.

6. Price discrimination may become possible when several groups of buyers require the same service for clearly differentiated commodities. For example, railways charge different rates of fare for the transport of cotton and coal. In this case price discrimination is possible since bales of cotton cannot be turned into loads of coal in order to take advantage of the cheaper rate of transport for coal.

WHEN IS PRICE DISCRIMINATION PROFITABLE AND JUSTIFIED;

• It is profitable for a monopolist when he charges a relatively higher price for those products having inelastic demand and lower price for the product having elastic demand.
• It is profitable to the general public only when price discrimination is allowed in public utility services and public sector. For example, railways, telephones, electricity, water supply department.
• It is profitable when community’s welfare requires price discrimination. For example, a doctor or a lawyer charge a relatively higher fees for rich customers and lower fees for poor people.
• It is profitable when the monopolists share a part of his total profit with co-workers in the form of higher wages, bonus, etc.
• When surplus production is cleared of in foreign markets at lower prices and promotes export of the country, then it becomes profitable to the society. 

Dr. Swati Gupta

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