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Price discrimination is one way to expand
sales market in a monopoly. A monopolist who produces less products and sells them at a higher price than in a purely competitive environment loses part of the potential buyers who are ready to purchase the goods if their price were lower than the monopoly. However, reducing the price in order to expand sales, the monopolist is forced to lower the price of all products sold. Therefore, in order to preserve gross income and profit, a company can set different prices for the same products for different groups of customers. If some buyers purchase products at a lower price than the rest, and these price differences are not justified by differences in costs, then there is a practice of price discrimination.
The term “discrimination” does not contain an ethical meaning, but is used to separate the phenomenon indicated by it with price differentiation depending on the quality of goods and services.
Price discrimination is subject to the following conditions:
• the buyer, purchasing products, does not have the opportunity to resell it;
• it is possible to divide all consumers of these products into markets for which demand has different elasticities.
For price discrimination, simply dividing the market into parts is not enough; it needs to be divided so that parts of the market are separate, isolated markets. The demand for each of them will not depend on prices that are set on another market, it will be impossible to resell the goods. Markets can be divided geographically or through tariff barriers. In either case, moving goods from a relatively cheap market to one where they can be sold at a higher price entails significant costs, which is an obstacle to resale (movement).
The unity of the market may be violated when essentially the same goods are sold under the guise of goods of different quality. Snob buyers, when purchasing expensive goods, stand out among relatively poor buyers. Thus, the market is divided and the monopolist gets the opportunity to conduct price discrimination.
The basis of different prices for this single product is a different elasticity of demand in isolated markets.
Let a monopolist conducting price discrimination conduct trade in two markets - 1 and 2, which are characterized by demand lines D1 and D2, respectively.
Market 1 is smaller in volume but more elastic. MR1 and MR2 are the corresponding lines of marginal revenue (Fig. 8).
Fig. 8. Price discrimination.
How is the total supply between the markets distributed? If, for example, MR1> MR2, then it is beneficial for the manufacturer to transfer part of the goods from market 2 to market 1.
In this case, MR1 will decrease, while MR2 will increase. And only with MR1 = MR2 the redistribution of goods between markets will not lead to an increase in total revenue. This will be the most profitable distribution of goods between the markets. Therefore, we can build the line of total marginal revenue MRT by performing horizontal summation of the curves MR1 and MR2, i.e., adding up the supply volumes at the same MR values. The intersection of MRT with MC - marginal cost curve - determines the total QT output. The horizontal line MRE passing through the point of intersection E is the line of equal marginal revenue. The intersection points of the МRE line with the marginal revenue lines MR1 and MR2 allow you to determine sales volumes and prices for each market. In market 1, Q1 units of goods will be sold at the price of P1, and in market 2, Q2 units of goods at the price of P2. We get: marginal revenue in each market is the same and equal to the total marginal revenue and marginal cost of all products (MR1 = MR2 = MRT = MC).
Marginal revenue is related to price elasticity (E) of demand by the ratio
Therefore, the equality MR1 = MR2 can be represented as
If the elasticity of demand is the same (E1 = E2), then prices (P1 = P2) will be equal, that is, price discrimination is impossible. Provided that the elasticity of demand in different markets is not the same, the prices will be different. If the absolute value of the elasticity of demand in market 1 is greater than in market 2 (| E1 | <| E2 |), the price in market 1 will be less than the price in market 2 (P1 <P2). The price that will be established in each market will turn out to be the price of demand for all products sold there.
So, a monopolist can make more profit if he sells less products in markets where the elasticity of demand (and marginal revenue) is lower; in the same markets where the elasticity of demand (and therefore marginal revenue) is higher, it will sell more products. The sales volume will then be established at a level at which the marginal revenue from the sale of an additional unit of output will be equal in all markets. And if his marginal revenue from the sale of products in each of the markets is equal to his marginal cost of producing all the products sold, then the monopolist will receive the greatest profit.
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